The estate and gift tax is a tax on the transfer of wealth from one generation to the next. The tax is levied when a transfer occurs, which by lifetime gift, or upon death.
The estate and gift tax rates start low. The Massachusetts estate tax affects estates worth more than $1 million. The marginal rates start at 4%, and rise gradually to 16%. Federal estate taxes kick in at $5.34 million, but the marginal rate is 40%. The top marginal rate for combined federal and Massachusetts estate taxes is 49.6%.
What People of Moderate Wealth Do
People of moderate wealth can greatly reduce, and often eliminate, their estate tax burden through fairly common estate planning techniques. Marital deduction/credit shelter planning can double the amount that a couple can pass free of the Massachusetts estate tax. Annual exclusion gifting can simply and easily reduce future estate taxes. Charitable giving also reduces estate taxes
With proper planning, a couple worth $2 million can reduce their tax bill from around $100,000 to zero. A couple worth $10 million can reduce their estate tax from around 25% to around 5%.
What Very Wealthy People Do
Individuals and families with more than $10 million can take advantage of a variety of sophisticated estate planning techniques. One of the most common techniques is called a “zeroed-out grantor retained annuity trust” or “GRAT” for short. Here’s how it works.
The person setting up the GRAT is called the Grantor. The Grantor puts money into the GRAT. The GRAT then provides an annual payment to the Grantor for a predetermined number of years.
The present value of these future payments can be calculated based on interest rates set by actuaries at the IRS. Currently, these interest rates are very low. They change each month, but have been hovering around 2%. The Trustee of the GRAT invests the GRAT’s money. If the investments earn more than the predetermined interest rate, then the GRAT will still have some money left, even after it makes its final annual payment to the Grantor. The money that is left over passes to the Grantor’s children (or anyone else specified) free of estate and gift taxes.
Here’s how it looks with actual numbers. The Grantor puts $5 million in the GRAT for a term of five years, when the IRS interest rate is at 2%. The Trustee invests the money, and earns 8% return per annum. The Trustee pays the Grantor $1,061,000 per year. At the end of five years, the GRAT still has $1,123,000, which goes to the next generation free of taxes.
It’s not uncommon for very wealthy families to have multiple GRATs going at the same time, or to roll over new two-year GRATs each year indefinitely. If the GRAT’s investments appreciate in value during its term (think family business stock), then the tax savings can be astounding.
Bloomberg recently published an article on this strategy, using Las Vegas Sands Corp. owner, Sheldon Adelson, as a case study.
The lesson to be learned is that families of moderate wealth face steep taxes, and very wealthy families face even steeper taxes. Fortunately, there are plenty of ways to mitigate these taxes through proper planning. Don’t give your wealth to the government. Give it to your family.