There are several proposed tax policy changes surrounding capital gains rates, gift and estate taxes, and lifetime giving exclusions that will make it more difficult for high-net-worth individuals to transfer wealth. It is essential to stay informed and work with your CPA and estate attorney to ensure you have the appropriate trusts in place to protect your wealth and the future generations who will benefit from it.

We collaborated with Austin-based Estate Planning Attorney Julia Nickerson of Nickerson Law Group PC to highlight some important items HNW individuals need to be aware of for the 2021 tax year and options to mitigate them.

What are the rumored tax policy changes for 2021?

As a follow-up to the American Rescue Plan (enacted in March 2021), the proposed American Families Plan includes several tax changes that could have a significant impact on generational wealth transfer.

  • Ordinary income tax rate increase: The top income tax bracket ($452,700 a year for individuals and $509,300 for joint filers) would see their tax rate increase from 37% to 39.6%.
  • Capital gains and dividends rate increase: Households making over $1M would pay the same 39.6% rate on all income, including capital gains and qualified dividends.
  • Elimination of “step-up in basis”: There is currently an estate tax law provision that allows the basis of an asset to be adjusted to the value at the time of the owner’s death, rather than the value when originally purchased. This is referred to as a “step-up in basis,” and the proposed plan would eliminate this provision for gains in excess of $1M.
  • Taxing unrealized gains for gifts: Current tax laws allow accumulated gains to be passed down untaxed from generation to generation via gifts. The new plan would make these gains taxable (above $1M for individuals or $2M for joint filers).
  • Limiting 1031 exchanges to $500K: IRC Section 1031 allows you to postpone paying tax on gains if you reinvest the proceeds in similar property as part of a qualifying like-kind exchange. [1] The proposed tax changes would limit the eligible amount of this deferral to a maximum of $500K of gain.

The combination of these proposed changes could result in a material difference, as illustrated here for a sample asset valued at $100M:

Source: Tax Foundation

When should individuals start setting up trusts?

Living trusts are always recommended for basic estate planning to avoid probate. For more advanced estate tax planning, our general recommendation for timing is when the estate value is getting close to $5M. Attorneys and CPAs who specialize in this area of tax law can be extremely busy, so it’s a good idea to develop a relationship early. When it comes time for in-depth planning, you will already have a team who truly understands your particular situation and can implement creative tax savings strategies at the right time.

Right now, many HNW clients are looking at creative ways to use the high lifetime exclusion before it is significantly reduced by potential tax law changes. There is also pending legislation that may remove the ability to apply “lack of marketability” and “lack of control” discounts when valuing family-owned businesses. Families who own controlling or majority interest in businesses are looking to implement gifting or sales strategies now, ahead of any changes in the law.

Five Popular Types of Trusts and Their Tax Benefits

Here are a few of the most widely-used trusts that function to lock in the value of the assets for estate tax purposes:

  1. Beneficiary Defective Inheritor’s Trust (BDIT)
    Created and funded by a third party, the beneficiary is the ‘owner’ of the trust from an income tax standpoint, while the assets are held outside of the estate for estate tax purposes.Individuals can sell interest in highly appreciating assets at a reduced value to the BDIT and take back a promissory note (taking advantage of the current low interest rates.) We recently completed a BDIT transaction where the taxpayer sold a business to his BDIT in exchange for a note receivable. The note receivable is in his estate, but the business is held in the trust. All appreciation will be outside of the estate, and he will save 40% on the value that passes through the trust.
  2. Spousal Lifetime Access Trust (SLAT)
    Assets are gifted to an irrevocable trust to benefit the other spouse (and sometimes their children) during the donor’s lifetime. Assets gifted to a SLAT are not included in the estate of either spouse. Many individuals are taking advantage of the high lifetime exclusion and gifting into these trusts before the limits change.
  3. Intentionally Defective Grantor Trust (IDGT)
    Assets are placed in an irrevocable trust where the grantor is the ‘owner’ from an income tax perspective, but not from an estate tax perspective, as the assets are no longer part of the estate. The grantor pays income tax on the growth of the assets that will be passed down to their children/grandchildren, while the value of the assets grows outside of their estate.
  4. Charitable Remainder Trust (CRT)
    Assets are gifted to an irrevocable trust where the donor receives income from the trust for a defined term (“x” years or life), and the charity receives the remaining assets at the end of the term. Donors receive an income tax charitable deduction when the trust is funded.These trusts are beneficial for those who are charitably inclined and want to avoid hefty taxes in an exit year. We recently set up a CRT for a client with an eight-figure Crypto portfolio, allowing them to liquidate the portfolio without excessive taxes.
  5. Charitable Lead Annuity Trust (CLAT)
    Assets are gifted to an irrevocable trust, which then pays an annuity to the donor’s chosen charity each year, allowing the donor to take advantage of income tax deductions. At the end of the term, any assets remaining pass to the donor’s beneficiaries tax-free.

What is the biggest tax mistake when transferring or inheriting wealth?

Doing nothing or even just procrastinating can be the biggest mistake. Educating yourself and making simple moves early on can save millions of dollars down the road. Trusts offer taxpayers a huge opportunity to reduce income and estate taxes. Any entrepreneur with a rapidly growing business needs to be familiar with trust tax planning. The same goes for individuals with a large estate made up of traditional investments and real estate.

Many people wait to do any planning until it is too late – a catastrophic event has already happened or the law has already changed. Several strategies work best if implemented before a business is ripe for sale. Laws change, priorities change, families change. Developing a relationship with a trusted specialist and scheduling time to review your planning and strategies at least every three years is highly recommended.

Who should you work with to set up a trust?

Your starting point should be finding an experienced estate planning attorney who can work hand-in-hand with your family’s CPA. A great CPA will be your most trusted advisor and will know the family financial picture better than anyone else. They can help communicate in simple terms to both the family and the estate attorney. You’ll also want to coordinate with your financial advisor to ensure the proper asset types are held in each type of trust with income and estate taxes in mind. Life insurance is an integral part of larger estate plans and you’ll want to build that into your overall structure as well.

While navigating estate planning can seem daunting, putting your plan together now with the knowledge and expertise of seasoned professionals can provide much-needed peace of mind. Whether you’re ready to begin the process or want to review your existing plan relative to the potential upcoming changes, we’d love to help. Contact us today!


[1] Like-Kind Exchanges Under IRC Section 1031