It's time to create an estate plan to take advantage of the big tax exemption


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Owners of large estates have reason to celebrate. For the second year in a row, the estate-tax exemption has increased to keep up with inflation, offering families with substantial assets the ability to shield a bigger portion of their estates from estate tax.

For 2020 the Internal Revenue Service raised the estate tax exemption to $11.58 million per individual, or $23.16 million per couple. A provision of the Tax Cuts and Jobs Act of 2017 more than doubled the exemption and raises it each year to keep pace with inflation.

That gives entrepreneurs and small business owners an opportunity to shield more of their assets from estate taxes. If you hope to take advantage of today’s generous exemption amount, you’d better act fast, though. The current threshold is set to expire at sunset in 2025, at which time it could revert to the pre-2018 exemption level of $5 million (indexed for inflation) for an individual taxpayer.

The sunset could come even sooner if Democrats sweep the legislative branch and the presidency. The party has made no secret of its disdain for the tax law that reduced the tax burden on wealthy taxpayers.

For now, here’s what you need to know to make the most of your estate planning, according to experts.

Strike while the estate-tax exemption is high

Estate planning is always an inexact science. Political sentiment changes, budget priorities shift, and fiscal realities set in. Because of the inherent uncertainties, estate planning professionals urge entrepreneurs to take advantage of favorable conditions when they can.

One common strategy is to make gifts up to $11.58 million during your lifetime because every taxpayer has the ability to transfer that amount while they are alive or at their death without incurring estate tax.

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“Many entrepreneurs and small business owners are not effectively using their gift tax exemption, which will reduce the size of their estate,” said Andrew Sherman, an estate planning attorney and partner with Seyfarth Shaw.

Transferring appreciating assets — such as a stake in your business — offers even more tax savings potential, especially if your business is still in its early stages. For example, say you gifted $1 million of your business to one of your children, but at the time of your death, those shares were worth $10 million. By making the gift early, you’ve only used up $1 million of your exemption.

“If you have shares in your own business, you can gift [them]; then the appreciation takes place out of your estate,” said Michael Garry, a fee-only certified financial planner and lawyer at Yardley Wealth Management in Newtown, Pennsylvania.

The annual gift exclusion is $15,000. There’s no tax owed up to that amount. Gifts over that amount start to chip away at your lifetime gift exemption of $11.58 million. Experts advise that you take advantage of today’s favorable estate tax environment because it’s unlikely to come around again.

Harry Drozdowski, director, legacy and wealth planning with Abbot Downing, the ultrahigh-net-worth unit of Wells Fargo, described how this worked for a client recently. The entrepreneur had just started his business and transferred a 25% stake in his company into a trust for his two children, who were 10 and 8 at the time. A year later the business sold for more than $1 billion.

“It cost him $50,000 in exemption because the business wasn’t worth anything at the time, but now $250 million is out of his estate,” Drozdowski said. “That’s why I always say the earlier you start, the better.”

You can also use these gifts for philanthropic pursuits. “Many entrepreneurs are generous, but they have not set up foundations or transferred assets, which would exempt those assets out of their total estate,” noted Sherman.

Even better: The IRS recently issued a ruling that it wouldn’t “claw back” those large gifts should the estate tax exemption revert back to the old threshold after 2025, giving taxpayers assurance that any planning they do today will hold up. However, if you don’t use up the full exemption amount and the threshold does get reduced in the future, you won’t be able to do so retroactively.

Keep control

While some strategies make sense from an estate tax perspective, they may not sit well with entrepreneurs who are used to being in control. You need to to be able to balance the need for estate planning with what’s good for your business, too.

“A lot of [estate] planning means giving up some kind of control [over your assets], and many entrepreneurs don’t want to do that if they don’t have to,” Garry said.

One strategy is to reorganize your business so that you have both voting and non-voting shares.

“Then you can take non-voting shares and put them in trust for your children or other family members so you’re able to make the gift and still retain direct control of the business,” explains Marve Ann Alaimo, an estate lawyer and partner with Porter Wright Morris & Arthur in Naples, Florida.

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Make sure you take care of succession planning, too

For many entrepreneurs, their business makes up the lion’s share of their estate. That’s why succession planning needs to be at the center of any estate plan, experts said.

“If [entrepreneurs] don’t get their act together, they won’t have an estate for estate planning,” cautioned Sherman. “Many small business owners don’t even know what their business is worth.”

In fact, according to Rocket Lawyer, the online legal advice company, 72% of small businesses don’t have a succession plan. The reason? According to surveys by Wilmington Trust, 8 in 10 entrepreneurs admit to being too preoccupied with their business to develop one.

“I’ve seen entrepreneurs die and have their businesses go through probate,” said Leon LaBrecque, a CFP with Sequoia Financial Group in Troy, Michigan. “The business ended up dissolving because by the time it was all done, all the customers were gone and the only people who got anything were the lawyers.”

Proper succession planning isn’t just about protecting your family but also your employees. Forty-seven percent of the private-sector workforce works for a small business.

“You have a moral and social responsibility to put a succession and transition in place, not just to protect your own personal wealth but because it’s the right thing to do for your employees,” Sherman said.

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Disclosure: NBCUniversal and Comcast Ventures are investors in Acorns.



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