Prepared by Christopher Klug – Co-Founder, Basswood Counsel PLLC.
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Where Income Tax Planning Collides with Estate Tax Planning
Almost all family offices have a structure that includes ownership of the family office partially through a dynasty trust for efficient estate and gift tax planning. The assets held in a dynasty trust are generation skipping transfer tax exempt and therefore the assets that are held in the dynasty trust are not subject to estate tax at each generational level, thus avoiding a haircut of wealth of 40 percent at each generation. The dynasty trust allows for the preservation of significant wealth to the family.
The limitation to dynasty trust planning is the estate, gift, and generation skipping transfer tax exemption of $13.61 million for 2024 or $27.22 million per married couple (collectively, “Transfer Tax Exemption”). While $13.61 or $27.22 million is more wealth than most individuals have, there are a number of individuals that exceed this amount and have wealth into the hundreds of millions to billions. For a well-planned family office, this results in part of the interest of the family office being held by the dynasty trust and part of the interest in the family office being held outside the dynasty trust and subject to estate tax.
Years ago, there were estate freeze techniques that were used to pump more assets into a dynasty trust with little use of the Transfer Tax Exemption. The Internal Revenue Code now has specific rules that preclude this planning.
Family offices in part typically act as investment vehicles for the family. The family typically has accumulated a lot of wealth over the years and now through the family office the family invests in a number of companies seeking large returns.
At most law firms, the corporate and partnership tax attorneys are separate and have limited understanding of estate tax planning. Similarly, estate planning attorneys typically have limited knowledge of corporate and partnership tax. This limited understanding of different areas of tax law and the lack of appropriate collaboration across departments leads to missed opportunities in planning for the family office.
For example, a family office with assets of $100 million is currently owned by one individual. The individual has transferred interests in the family office to a dynasty trust exhausting his or her generation skipping transfer tax exemption and the family office interest held by the dynasty trust currently has a value of $20 million.
Under the right circumstances, the family office can be restructured to allow significantly more of the family office value to transfer into the dynasty trust with no use of the Transfer Tax Exemption. For example, assume in the example above the family office doubles in value within 10 years. If the family office were restructured properly, perhaps the family office interest being held by the dynasty trust instead of being worth $40 million, it is worth $70 million, that would save the family a significant amount in estate tax and preserve significant additional wealth for generations.
To properly plan for the family office it is important that the tax planner has a strong background in corporate and partnership tax and estate and gift tax to be able to think through the most efficient options. Too often, little thought is given to how the different tax rules intersect and the planning opportunities, and the planning is based solely on the practitioners practice area for example estate planning, thereby limiting the planning options to the client. We have the background to comprehensively plan for a family office to develop the most tax efficient results for generations into the future.