As a business owner, you might be aware of the upcoming sunset of the federal gift and estate tax exemption. Unless legislative changes are made, the current lifetime exemption, which allows you to transfer assets without incurring federal gift or estate taxes, stands at $13.61 million per individual and $27.22 million for married couples. However, this exemption is set to decrease on December 31, 2025, reverting to pre-2018 levels. This means the exemption will drop to around $7 million per individual, adjusted for inflation.
This upcoming change is particularly relevant for individuals with a net worth exceeding $14 million and those planning a business sale within the next 18 months, as the sale may push their estate above the exemption threshold. Once the exemption reverts, any amount above it could be taxed at a 40% rate upon death.
For business owners expecting to sell their businesses in the near future, time is of the essence. Implementing estate planning strategies now can help mitigate future tax liabilities, but it’s important to begin well in advance of any signed agreements or letters of intent (LOIs). The IRS closely scrutinizes planning done after a deal is in motion, so starting the process at least 6-8 months before a transaction is recommended.
Fortunately, the IRS has clarified that if the exemption amount decreases, there will be no "clawback," meaning assets transferred under the current higher exemption won’t be pulled back into the estate later.
To minimize the impact of the impending changes to the estate tax exemption, here are a few strategies to consider:
Spousal Lifetime Access Trust (SLAT): A SLAT allows you to transfer assets outside your estate while still providing indirect access to those assets through your spouse. While the assets are no longer part of your estate, your spouse can access them if needed, providing flexibility for couples who may be uncertain about their future financial needs.
The key benefit of a SLAT is that any future growth of the assets within the trust is excluded from your taxable estate. This strategy is particularly useful for those who want to transfer wealth without fully relinquishing access to the assets during their lifetime. Business owners who delay setting up a SLAT until after the exemption decreases may miss the opportunity to shield up to $13.61 million from estate taxes, instead being limited to the reduced $7 million exemption.
Charitable Remainder Unitrust (CRUT): A CRUT is another powerful estate planning tool, especially for business owners anticipating a liquidity event. A CRUT allows you to donate assets, such as appreciated stock or business interests, to a trust that pays you (and potentially other beneficiaries) an income stream for a specified period of time or for life. After the income term ends, the remaining assets are donated to a charitable organization of your choice.
One of the significant benefits of a CRUT is that it allows you to avoid immediate capital gains taxes on the sale of appreciated assets placed in the trust. This can be particularly advantageous for business owners planning to sell their companies at a significant gain. By transferring business interests to a CRUT before the sale, the owner can defer the capital gains tax and receive a charitable deduction for the donation, potentially reducing their overall tax liability.
Additionally, the assets in the CRUT can grow tax-deferred, allowing the trust to provide a steady income stream over time. Once the trust’s term is complete, the remaining assets go to the designated charity, aligning with philanthropic goals while providing tax benefits. For business owners looking to balance estate planning with charitable giving, a CRUT offers a flexible and tax-efficient solution. View an example below:
Sale to a Defective Grantor Trust (Installment Sale): Similar to a SLAT or CRUT, an installment sale to a defective grantor trust allows business owners to transfer assets outside of their estate. In this strategy, business stock is sold to a trust in exchange for a promissory note. The stock remains outside the taxable estate, and only the IRS-mandated interest needs to be paid annually.
With this approach, the business owner can defer capital gains taxes and reduce estate taxes while maintaining control over the business assets through the promissory note. This is especially useful for business owners whose liquidity event may not happen immediately, as it offers flexibility in managing both income and estate taxes over time.
These strategies—SLATs, CRUTs, and installment sales—can be implemented alone or in combination, depending on the specific goals of the business owner. However, with the estate tax exemption set to decrease in the near future, acting now to preserve wealth and minimize tax liabilities is crucial for those planning a significant business transaction or facing an estate above the new exemption limits.
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