An important aspect of estate planning is considering the eventual estate tax and analyzing available liquidity sources to manage the tax bill. Gift planning follows as a next step to mitigate the estate tax. In addition to utilizing the gift tax exemption while it's available, currently $12,920,000 per person, lifetime giving is more effective. For one, post-gift growth on assets is also out the estate. Further, through use of a "grantor trust" where the grantor who funds the trust continues to be responsible for the taxes, the gifted assets grow tax-free while the grantor's estate is depleted by the income taxes paid. Common gifting trusts include:
- Intentionally-Defective Grantor Trust (IDGT) - referred to above, this type of trust is very effective for gift and estate tax purposes because the trust is able to keep the gross proceeds on its investments. This type of trust can also be leveraged by the grantor selling additional assets to the trust in exchange for a promissory note with interest at the IRS minimum rate for related party loans. Because the grantor is the taxpayer, a sale is disregarded for income tax purposes, as are the interest payments on the note. Where available, generation-skipping transfer (GST) tax exemption is often allocated to a grantor trust so that its assets can be used for multiple generations without further transfer taxes. If a trust is fully GST exempt at the time it is funded, all of the growth in the trust will also be GST exempt.
- Irrevocable Life Insurance Trust (ILIT) - life insurance proceeds are subject to estate tax if owned by the insured at death. As a result, ILITs are commonly used to acquire life insurance policies. A typical ILIT will include withdrawal rights for the beneficiaries that qualify for the annual exclusion from gift tax, and each year as premiums come due, the grantor would gift cash to the trust and, subject to the withdrawal rights, and the trustee would use those funds to pay the premium. Depending on the annual premium and the number of beneficiaries, an ILIT can be funded without making a taxable gift and all of the insurance proceeds would be out of the insured's name for estate tax purposes.
- Grantor Retained Annuity Trust (GRAT) - A GRAT is a specific exception described in the Treasury Regulations to the Tax Code provision that values a retained income interest at zero. A GRAT qualifies for the exception because the grantor is entitled to a fixed annuity over the term of the GRAT. A GRAT can be structured so that the annuity paid over the term equals the present value of the assets contributed to the GRAT (called a "zeroed-out GRAT"), which results in the remainder interest (and therefore the value of the gift) being worth $0. If the investments grow more than the IRS assumed rate of return, the the excess appreciation passes to the remainder beneficiaries gift-tax free. For this reason, GRATs can be very effective at pushing appreciation out of the grantor's estate.
- Non-Grantor Complex Trust (NGT) - A non-grantor trust is a trust that is a separate taxpayer. It's less gift and estate tax efficient relative to so-called "grantor trusts" but if the trust is not subject to state income tax, that may result in a lower overall tax liability.
