IBA, as the premier business brokerage firm in the Pacific Northwest, is firmly established as a respected professional service firm in the legal, accounting, banking, mergers & acquisitions, real estate, and financial planning communities.  Periodically, we will post guest blogs from professionals with knowledge to share for the good of owners of privately held companies & family owned businesses. The following blog article has been provided by Spencer Gauta of Northwestern Mutual (https://www.northwesternmutual.com):

Not All Sunsets Are Pretty: The Ugly Truth of How the TCJA Could Affect Your Legacy

One of the most alluring parts of building and selling a business is creating a legacy for the people and causes you care about. Just like a business, creating a well-thought-out financial plan capable of distributing wealth long after you are gone takes hard work, dedication, and the ability to take advantage of any favorable circumstances facing you. The Tax Cuts and Jobs Act (TCJA), arguably the largest tax overhaul in recent US history, created one of these favorable circumstances. Currently, many of the provisions in the TCJA are set to sunset at the end of 2025, one of which doubled the estate tax and gift exemptions. Understanding the effects these changes could have on your finances and business and doing the proper planning ahead of time could have massive ramifications for your legacy.

Odds are that there will be a significant debate on Capitol Hill regarding estate and gift tax exemptions in 2025. Though, whether Congress decides to follow the lead of the TCJA or go in a totally different direction is yet to be seen. If leaving your financial plan and your legacy to the mercy of Washington political theater doesn’t sound appealing to you, then you’re in luck. You have other options.

Here’s what you need to know.

A Crash Course in Estate and Gift Taxes

Let’s start with the basics here. There are three types of taxes the federal government imposes when transferring wealth:

Estate Tax: Applies to wealth transferred above the exemption threshold upon death. Taxed at a flat 40% rate.

Gift Tax: Applies to wealth above the exemption threshold transferred during life.  Taxed at a flat 40% rate.

Generation Skipping Tax (GST): A separate 40% tax layered on top of any transfer made to a grandchild or further descendent.

Luckily, there is a total amount of wealth you can transfer before getting hit with any of these taxes. Once the law sunsets, though, those exemptions are getting slashed in half. With inflation continuing to increase, that means your roughly $14 million dollar exemption in 2025 turns into a roughly $7 million dollar exemption in 2026, or roughly $27 million to $28 million down to $13.5 million to $14 million if you’re married. Also, keep in mind, these are unified exemptions; you don’t get two separate exemptions for the Gift Tax and the Estate Tax.

How do I Take Advantage of the Exemptions Before They Expire?

The most obvious courses of action here are to either pass away before 2026, or, if you plan on sticking around a little longer, gift a total amount of wealth equaling your exemption before the TCJA sunsets at the end of 2025. Some of the best ways to do this are as follows:

• Make a Gift to a Dynasty Trust

The idea here is to reallocate wealth that is in your name to that of an irrevocable trust, creating an entity that can distribute wealth to later generations, potentially forever. Gifts to an irrevocable trust or distributions from one to generations beyond your children could trigger a GST tax. Taking advantage of the Gift and GST exemptions now allows you to gift double the wealth to a dynasty trust than you otherwise would before the TCJA sunsets at the end of 2025, protecting all the trust’s assets and distributions from the GST forever regardless of the size of the distributions.

• Make a Gift to a Trust That Owns Life Insurance

Generally, life insurance does not trigger income tax. Building off the above idea, gifting wealth up to the current exemptions to a properly drafted and administered irrevocable trust that owns life insurance could be a viable strategy to minimize estate taxes and income taxes when passing wealth to future generations.

• Gift Fractional Interests of Your Business

Fractional shares may be able to have a discount applied when determining an asset’s fair market value. This can be due to reasons ranging anywhere from being a minority interest, lack of marketability, having no voting rights, or for other similar reasons. That means if you were to gift a percentage of your business, you can gift a proportionally higher percentage of your business in fractional shares than you could with a straight proration of the whole business without triggering the gift tax. Furthermore, if that gift were made to an irrevocable trust, the growth of that business is outside of your estate. The grantor trust classification means that the tax owed on the income generated in the trust is paid by you (outside the trust) ensuring that any wealth inside of the trust is not depleted by taxes and it will not be counted as you giving additional gifts to that trust.  Due to the complexities of this topic, we suggest seeking a financial professional that can assess your specific circumstances.

• Entirely Use Up Only One Spouse’s Exemption (only applies to married couples)

If you want to take advantage of the exemptions but are not ready to give up all your exemptions on your future estate or gifts, you can choose to use only one spouse’s exemption. The strategy here is to give gifts that are in the name of only one spouse and not both. The spouse who is gifting would give gifts from assets titled in his or her name only and not elect gift splitting. The other spouse would make no gifts during this time.

When it comes time to leave future gifts or pass on wealth in the future, then all gifts or wealth passed on would be in the name of the spouse who did not use up their exemption. It should be noted that the remaining exemption will still be subject to the sunset of the TCJA at the end of 2025 and all the changes that come with it.

Closing Comments

With 2025 fast approaching, the window to act is quickly shrinking. Creating a well-though-out financial plan takes time and has many moving parts. The sunset of the Tax Cuts and Jobs Acts will not be a pretty one for those looking to leave a legacy. What Congress and the White House choose to do with the US tax code in the aftermath is entirely uncertain. If you want to ensure that your hard-earned wealth gets passed on with potentially the highest transfer tax exemptions we may see ever in our lifetimes, then the time to act is now.

If you have questions relating to legacy planning, the content of this article, or issues with wealth advisory in general, Spencer Gauta would welcome the opportunity to talk with you. Mr. Gauta can be reached at (239) 285-5479 or spencer.gauta@nm.com.

Spencer Gauta is an Insurance Agent of The Northwestern Mutual Life Insurance Company (NM). Investment brokerage services provided as a Registered Representative of Northwestern Mutual Investment Services, LLC. a registered investment adviser, broker-dealer, and member of FINRA and SIPC.  Investment advisory services provided as an Advisor of Northwestern Mutual Wealth Management Company a federal savings bank. NM and its subsidiaries are in Milwaukee, WI.

This publication is not intended as legal or tax advice. It must not be used as a basis for legal or tax advice and is not intended to be used and cannot be used to avoid any penalties that may be imposed on a taxpayer. Financial advisors do not give legal or tax advice. Taxpayers should seek advice regarding their particular circumstances from an independent legal, accounting, or tax advisor. Tax and other planning developments after the original date of publication may affect these discussions.

IBA, the Pacific Northwest’s premier business brokerage firm since 1975, is available as an information resource to the media, business brokerage, mergers & acquisitions, and real estate communities on subjects relevant to the purchase & sale of privately held companies and family owned businesses.  IBA is recognized as one of the best business brokerage firms in the nation based on its long track record of successfully negotiating “win-win” business sale transactions in environments of full disclosure employing “best practices”.