Why the IRS Shouldn’t Be Your Biggest Heir

Speaker 1 – 00:00
One of the big problems is real estate and business interest is not going to be liquid.
Speaker 2 – 00:04
These are as high as these limits have ever been.
Speaker 1 – 00:06
If they inherit millions of dollars from you and they get divorced, if the money’s in a trust, it’s essentially a prenup.
Speaker 2 – 00:12
Without a prenup, the trust planning is super important.
Speaker 1 – 00:14
It is not advantageous from a tax standpoint to have life insurance or a Roth IRA go to charity. If you don’t do
anything, even if you’re not in that super high net worth range, some of this will still apply to you. It would be
optimal to think about this stuff.
Speaker 2 – 00:29
One of the main strategies that we see address this problem is Jameson, today we’re going to talk about why the
IRS shouldn’t be your biggest heir. Specifically some tax strategies that a lot of our clients are putting in place to
make sure that they’re not paying the IRS more than they necessarily want to. So Jameson, why is this such a big
deal? What are some things that we should be thinking about before we dive in?
Speaker 1 – 00:57
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Where this is most applicable is high net worth space. And we’d be talking over like 30 million doll of net worth. But
however, this does apply to everybody because like we’ll talk about in the state of Pennsylvania, there’s an
inheritance tax on all assets except for life insurance. So if you are in that, you know, first subset of the high net
worth, you could, without proper planning, like there could be like a 50% tax on your estate if this isn’t done
correctly. So Ben, why don’t you give us an overview of the huge bill that was just passed a month or two ago, did
change some things with the estate taxes on a federal level. So Ben, why don’t you just give us an overview of like,
what’s the estate tax look like federally? Yeah, let’s start with federal.
Speaker 2 – 01:39
Yeah, right now you have a $15 million credit that you can pass without owing any federal estate tax. So let’s say
There’s a couple, two spouses that are married. One spouse has 15 million they could pass. The next spouse has
another 15 million they can pass. So combined they can pass 30 million without having to pay any federal state
tax. Any assets above that are taxed at 40%. Just basic example, let’s say someone has a $60 million net worth.
The first 30 million that they can pass is not subject to estate tax. That 30 million above it will be subject to a 40%
estate tax. If they don’t do any of the planning that we’re going to talk about if they just kind of let it ride, that’s what
they would be, that’s what they’d be subject to.
Speaker 1 – 02:21
That’s all assets. So on a state level, sometimes certain assets could be exempt, but on a federal level, it’s all
assets. There’s going to be big number if you have a $100 million net worth. And one thing to note too, you
mentioned it’s 15 per person. Under current law, what’s called portability exists. So if one spouse dies, I’m blanking
on the tax form. But there’s a tax form you report when the first spouse dies that allows you to claim the deceased
spouse’s exempt or estate credit. So portability allows you to make sure you use that full 30 million. That hasn’t
always been in Milan. It may not be in the future. So that could go away. But as of right now, you get.
Speaker 2 – 03:02
30 million back to those limits. Because you just mentioned that could go in go away in the future. These are as
high as these limits has ever have ever been. There have been proposals to take these limits down. Right now
they’re 15 million. They’re scheduled to go up with inflation. But future administrations can very easily take this
down.
Speaker 1 – 03:17
In 2017, there was a tax reform passed and that bumped this up. What it was before this bill was 13.9 million,
13.99 person. And so that goes to 15. And the law is written to keep that permanent. However, I mean, realistically,
next administration gets in and their different political party or different political party gets in control of Congress,
this is probably going to change. It’s a very easy way for the government to take tax revenue.
Speaker 2 – 03:43
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Yeah, I think a lot of people zone out when they hear those numbers. They say 30 million. Like I’m not. Well, we
don’t have 30.
Speaker 1 – 03:47
This was 20 years ago. It was a million dollars.
Speaker 2 – 03:49
Right.
Speaker 1 – 03:49
So that would apply to a lot of people. Yeah, absolutely. Well, let’s go an example. Let’s say you have a hundred
million dollars. Just for the sake of like, let’s see what this actually looks like. Let’s use Pennsylvania, for example.
Every state’s different, but we’ll use Pennsylvania. Cause that’s where we’re at. What’s the Pennsylvania inheritance
tax?
Speaker 2 – 04:04
Yeah. So if you pass and you leave an account to your surviving spouse, there’s no inheritance tax. If you leave it to
any direct decedents, that includes like adult children, grandchildren, there’s a four and a half percent state
inheritance tax. If you leave it to any siblings, there’s a 12% inheritance tax and if you leave it to other heirs,
excluding charitable organizations, there’s a 15% inheritance tax.
Speaker 1 – 04:27
Okay, so we’re going to use the example Save $100 million, you die. We’re going to talk about federal assume
you’re in the state of Pennsylvania. We’ll assume everything’s going to go to your kids. So 4.5%. So in this example
we have 100 million, you die first, 30 is your state credit. So now we have 70 million and that’s going to get hit with
a 40% federal estate tax. That’s $28 million is going to the IRS on top of that, let’s say of the 110 million life
insurance. So in Pennsylvania that’s exempt from the four and a half percent, but the other 90 million, that’s
another $4 million. So of that 100 million, $32 million is going to the IRS and you’re going to net 68. So there’s a lot
of planning that needs done to deal with that.
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Speaker 1 – 05:09
One would be okay, let’s say most people in that net worth range, all of their assets probably aren’t like it’s possible
that you have $100 million in a brokerage account, but probably unlikely. You probably have some real estate, you
probably have business interest. And one of the big problems is that real estate and business interest is not going
to be liquid. If 50 or 60 million of that is made up of real estate or business, you’d have to sell it to pay for the, pay
for the taxes. There is a law, it’s over a certain percentage of your net worth. If it’s business interest, I don’t know
the percentage, but then you can pay it over like 14 years. But a lot of planning would need done.
Speaker 1 – 05:49
One, if you’re going to just pay the taxes, but there’s also planning that can get done as for as far as how do we
minimize this? So let’s go account by account. So that’s the estated inheritance tax. But you know, if someone
inherits a Roth ira, if someone inherits a pre tax ira, if someone inherits a taxable investment account, let’s talk
about how the life insurance, somehow those are taxed. So Ben, give us a rundown.
Speaker 2 – 06:09
Yeah, so let’s talk about pre tax accounts first. So if you inherit an Iraq 401k, you’re still subject to that state
inheritance tax. So let’s say you’re an adult children. Adult child I should say of your and you inherit the account still
subject to that four and a half percent. That’s regardless of estate size by the way. So someone can be over that
credit limit, someone could be under it, you’re still subject to the 4.5% and that you need to distribute that account
in a 10 year period. This is a new rule as of 2019 with the Secure act eliminated the stretch IRA.
Speaker 2 – 06:43
So previously before 2019, if you inherited a traditional IRA from your parent, you could stretch those distributions
amongst your lifetime so you didn’t have to take it out over a certain period to help lower any of the tax burden that
would come about when you took out those distributions. Secure act says you need to take it out in a 10 year
period. So every distribution you take is subject to ordinary income tax at your income rate. So this is a almost like
an unexpected tax bomb because every time that you take a distribution it’s almost like you’re adding income. So
regardless, let’s say you’re married, you work, your spouse works, you have your income, you take a distribution
from this inherited IRA that was an old 401k, let’s say it’s a hundred thousand dollars, you’re adding a hundred
thousand dollars to that income.
Speaker 1 – 07:33
You probably the estate paid 40% if you’re over that exemption. And now if you’re in a high tax bracket, you’re
paying another 30%, 37% to take the money out. Yeah. So there’s a lot of tax. Roth IRA is you still pay the
inheritance tax in Pennsylvania, again staying in the example, Pennsylvania, 4.5%. You still have to take the
account out over 10 years, still take the balance out, but you don’t pay tax on it. So that can be a good account to
pass on. And you’re still going to pay the federal estate tax if you’re over that credit number and a taxable
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investment account. So there’s what’s called a step up in basis that applies right now under current law. So if you,
Ben has an account that he’s got a million, he put in a million bucks and it’s worth 2 million.
Speaker 1 – 08:14
If he were to sell it, the million comes out tax free. He’s going to pay capital gains taxes on the million of growth. If
he passes it on to his kids, that basis gets stepped up at the day of death. So now the basis is $2 million. And
when they go to sell it, you know, if it grows from 2 million to 3 million, they pay tax on the minor growth. But if it
goes from, you know, their basis then becomes what it is the day of death. So that saves his kids on some things.
Right.
Speaker 2 – 08:40
You’re avoiding that million of growth that.
Speaker 1 – 08:43
You would otherwise 50,000 ish of taxes. Yet where that doesn’t apply is inside of a trust. Trusts do not get step up
in basis. And if you gift money outright to kids, if you own a stock and you gift it to them while you’re living, that
there’s no step of a basis. So I think that’s a pretty good overview of how all the taxes work. Now let’s talk about
certain strategies that we can do to avoid it, but anything to add?
Speaker 2 – 09:09
No, I think that pretty much sums it up. I would say one of the main strategies that we see for addressing this
problem years prior to when it actually is occurring is lifetime gifting. That’s utilizing your annual gift tax exclusion.
So right now that’s 19,000 a person that you can gift to an individual. Again, if you’re married, you can combine
with your spouse and gift 38,000 a year. And so money that you give to someone else, you are relinquishing it. It is
now out of your estate and that you would have otherwise paid 40% federal estate tax if you’re over any of those
limits. So we’re seeing a lot of gifting strategies, people getting money out of their estate. There’s a lot of advanced
strategies with that as well.
Speaker 2 – 09:52
But that’s really from a basic nuts and bolts standpoint, gifting money to other people to get it out of your estate.
Speaker 1 – 09:58
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On that example, if you. So you get a $19,000 per year person exemption that you can give.
Speaker 2 – 10:04
The reason why I say that is if you gift over that, you have to report it against your lifetime credit. So 19,000, it’s
almost like a freebie. You don’t need to file a form 709. It doesn’t count against any lifetime reporting. It’s very easy,
clean, no reporting.
Speaker 1 – 10:17
Yeah, you get the million. Now your credit’s 14 million. Yeah, but let’s use the example. You have two kids, two
spouses. You can give 19 person per spouse. So in this example, you know, it’d be $76,000 a year you can gift to.
And so there’s a couple ways you can do that. Number one, you gift it out, right? You could just write your kids a
check. Hopefully they’re responsible enough to deal with it. Second thing you could do is gift it into a type of trust,
which we’ll talk about. I’d say those are probably the two most common strategies. But regardless, let’s say you
took that 76,000 a year. Just to give you an idea of what this actually looks like in practice, that’d be about $6,333
per month.
Speaker 1 – 10:57
If you were to gift it in monthly over 30 years, if that grew a 7% growth rate, that is $7.7 million in that account at
the end of 30 years. So the way to look at that is that money is going to stay on your balance sheet to begin with. If
you didn’t gift it and if it’s invested, it’s going to grow to that almost 8 million. And then if you’re above that
exemption, 40% of that is going to go to the IRS. So that’s 3 million bucks. Whereas if you gift that over the course
of the next 30 years, that money’s going to accumulate outside of your estate, either in a trust or in your kids
names. And now that $8 million is out of your estate and going to avoid that $3 million tax.
Speaker 1 – 11:39
So there’s capital gains taxes that would have to be accounted for either way. But the bigger number is a 40%
federal estate tax that we’re a billion.
Speaker 2 – 11:48
Absolutely. And if you’re the gifter as well, a lot of people like to see their kids and grandkids actually using the
money. I think another way to do it is you don’t do any gifting and then you die and you leave everyone a bunch of
money and, but you don’t really know how they’re going to react to it. You don’t really know how they’re going to use
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it. And so doing that lifetime gifting not only saves from a tax standpoint, like you said Jameson, but you’re able to
see how your kids and grandkids react to the money and see how, you know, teach them almost how you got the
money and the values that kind of grew up with you. I think that’s really important.
Speaker 1 – 12:23
Yeah. And like I was just talking to a client yesterday that were playing for his inheritance from his dad and this
client’s in, you know, is about 40, the dad’s like 65. It’s millions of dollars that would be coming. And I said, well,
probably 30 years away, hopefully, you know, you hope your parents live a long time, but you’re 30 years away. And
so from the parents standpoint, if, you know, is it really helpful if your kids, you know, doing well for themselves and
earning money, is it really that helpful for them to inherit the money? It’s age 65. Sure, I’m sure it is. But they
probably would be more helpful to them to get some of the money earlier in life.
Speaker 1 – 12:59
So this annual gifting is a way to help them earlier on versus waiting till they’re, you know, 67 years old to inherit all
the money.
Speaker 2 – 13:06
Absolutely.
Speaker 1 – 13:07
And outside of that, 529s for grandkids are another way to get some money out of the estate. You can gift 19,000
a year. You can do what’s called a five year accelerated gift. So 95,000 person you can gift into a 529. Anything
else I’m gifting and then we’ll get into some trust planning.
Speaker 2 – 13:25
No, those were the two main hits.
Speaker 1 – 13:27
I wanted to hit well outside of that. So, you know, let’s say the kids aren’t. Could be a couple of reasons why I use a
trust. Number one, say kids aren’t old enough, they’re minors, or they’re, you know, not old enough. Where you
would want to give them money directly into their name. You could gift it into a trust. The trust could own life
insurance or an investment account and it could grow. And so that way when it, you still get all the tax benefits, but
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the money’s protected by the trust. And some of the benefits would be, number one, it’s creditor protected and
divorce protected, which I would say those are probably two of the main reasons why clients love putting money
into a trust when they die.
Speaker 1 – 14:02
I guess the more successful and more money you have, the more subject you are to a lawsuit. So creditor
protection is obviously could be helpful. But the bigger thing is, unless your kid gets married with a prenup, if they
inherit millions of dollars from you and they get divorced, the equitoc spouse is going to get probably half the
money. But if the money’s in a trust, it’s essentially a prenup. Without a prenup for that money, you know, if it’s
structured properly, they’re not going to be able to get the money in a divorce. So we have creditor protection,
divorce protection, and then rules on, you can set the rules however you want for when they can take the money
out. So you could say when they’re 30, 40, 50, whatever it is, they can.
Speaker 2 – 14:38
Be their own trustees so they can help oversee their own distributions. If you don’t think they’re responsible enough
for that, you can have a trustee that you appoint to help oversee distributions for them. But again, like you said,
Jameson, if the money’s in the trust, it has all those protections it avoids probate, it’s extremely private. As soon as
the money leaves the trust, it avoids those protections. So super important to have a structure for what money
stays in trust, what money comes out.
Speaker 1 – 15:02
So there’s a lot of different types of trust too. This is just like high level pool in general. But I mean, there’s certain
types of charity trusts, real estate trusts, annuity owned, trusted owned, annuities, all these different strategies that
could be, you know, too nuanced for this conversation. But outside of that there, I would say the other thing that
would be with real estate or business ownership, that can be a stressful topic when we’re talking about this net
worth range for a couple of reasons. Number one would be, does the kid want to be in the business or are they
capable of running the business? If you have a, you know, a business that’s in that type of net worth range, it takes
a special type of person to run it.
Speaker 1 – 15:40
And the second thing would be, I mean, it’s really, is what do we, what do we do with this thing? You know, taxes
are going to come into play, you know, if we die and nobody else is going to take the service, there’d be a lot of
taxes and business probably won’t exist. So there’s a couple of things you could do. Number one would be gifting.
We’ll use an example. This is a real life example with a client business valuation of about $30 million assets.
Outside of that, it’s another like 20 million. So we’ll say $50 million net worth. And they’re not married. So it’s a $50
million credit. They have more money. Adding all that up, they’ll never, they could triple their spending and they’ll
never spend all that.
Speaker 1 – 16:19
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What strategies we’re doing now is we’re saying, okay, while this credit is 15 million, it’s going to drop in the future,
probably let’s use this entire credit, get that 15 million out of your estate versus, you know, 20 years from now if it’s
5 million. We avoided, we missed out on that $10 million opportunity. So one thing we’re doing is it’s, it comes out
to use that 15 million plus some other assets comes out to gifting. We wanted to keep the parent have control. So
49% of the business was like 10 million bucks or something. So gifting the business into a trust plus some other
assets, some cash or stock, to use the 15 million credit. And now that’s going to do a couple of things. Number
one, you want to Put a highly appreciating asset into that trust asset.
Speaker 2 – 17:01
You think will grow over time.
Speaker 1 – 17:03
Yes, because if you just put, you know, real estate’s going to grow at 1% per year, you’re not getting all the tax. If
you have a business that’s growing at 20% rate per year, you get 15 in way down the road that 15 million is worth
30.
Speaker 2 – 17:14
And now all of that’s out of your.
Speaker 1 – 17:16
Yeah, we just saved a ton of taxes. But that does a couple things. One, it’s going to save on taxes. Number two, the
business is now owned by a trust for the beneficiary of the kid. So the kid can take the business over. But if the
kid’s not, you know, if it’s not going to work or the kid doesn’t want to do it’s now owned by a trust and it’s not
directly outright to them. So you have a lot of options on what you want to do with it. What to do with the business
in real estate can be a big topic. And the other couple of other strategies would be limited family partnership,
recharacterizing some of the stock to voting shares and non voting shares, having the parent own all the voting
shares and then transition the non voting shares to the kids.
Speaker 1 – 17:51
So the financial benefit goes to the kin, save on taxes, but the parent still has four control over. Anything to add
there?
Speaker 2 – 17:57
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No, that’ll make sense. The trust planning is super important. I mean the getting assets into the trust that you think
are going to appreciate that can be business interest, investment or stocks. And then life insurance, which we’ll
talk about more is another huge thing to have owned by a trust.
Speaker 1 – 18:13
One thing for life insurance, this is another low hanging fruit way to save a ton on taxes is if you have life insurance
that’s personally owned, that’s going when you die. Let’s say you have $10 million that’s going to pay out on your
balance sheet and then it’s going to be subject to those estate taxes. However, if you have life insurance that is
owned by a trust and the trust is paying the premiums and you die, that money gets paid out into the trust and it’s
not on your balance sheet. So that’s a very like easy way, just retitle and this depends on the cat if it’s whole life or
term and what the cash value is. But you just retitle the life insurance to be owned by a trust and now millions of
dollars out of your estate. So that’s an easy one.
Speaker 2 – 18:56
Two other Things I wanted to hit on. Number one, we talked about inheriting pre tax versus Roth accounts. Getting
more money into the Roth is super beneficial because your heirs, when they take distributions from an inherited
Roth account, don’t pay any income tax on that. So while you’re living, you can look to do Roth conversions.
Basically transitioning money from your traditional or pre tax account to your Roth account. You pay income tax on
that conversion itself. But once that money’s in a Roth, you never really pay any income tax on it. Again, it grows
tax free. And then when your kids inherit it, they take distributions over a 10 year period, it’s completely tax free.
Speaker 2 – 19:31
So we do a ton of Roth conversion planning with people in that age group that we’re looking to accelerate their
income up to like a 24% ordinary income range to just make sure that we’re doing those conversions and realizing
low tax brackets, but then also getting some benefit from for their kids whenever they eventually inherit the
account. And then the other thing would be just charitable planning. Charitable organizations don’t pay any tax
when they receive proceeds. So whether that’s, you know, you can leave a charity as a beneficiary on an account
and you can, they can inherit all of the assets completely tax free. You can do multiple, you know, donor advised
fund contributions to get money into an account that’s going to charity. There’s a lot of tax benefits to that. We’ve
done a few resources on that.
Speaker 2 – 20:17
And then you can do qualified charitable distributions or QCDs from your IRA once you turn 70 and a half. That’s
basically saying I’m taking my, what would have been my RMD and I’m giving it to charity. And so I’m avoiding tax
on that because it’s going to charity. So if you’re charitably inclined, there’s a lot of other doors that you can open
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from a tax planning standpoint.
Speaker 1 – 20:39
Yeah, I’m glad you brought that up. Because it is not advantageous from a tax standpoint to have life insurance or
a Roth IRA go to charity. So if you’re planning for this and you want to leave money to charity when you die, have
the pre tax IRAs go to the charity because you’re not going to pay taxes and the charity is not going to pay taxes.
Whereas the life insurance and the Roth IRA are tax advantageous, have that go to your kids so then they don’t
have to pay tax.
Speaker 2 – 21:08
Right. If you’ve got a $2 million traditional IRA, if you have the charity as the beneficiary, charity gets that 2 million
tax free. If you have the same $2 million IRA and your daughter’s a beneficiary, well, she’s got to take that out over
10 years and realize income tax. You’re exactly right.
Speaker 1 – 21:24
Yeah. I would say, just to wrap it up, one, if you don’t do anything, even if you’re not in that super high net worth
range, some of this will still apply to you. And so everybody, in my opinion, it would be optimal to do something or
think about this stuff. And the second thing would be outside of us from a tax standpoint, have these
conversations with beneficiaries too, so that they can get into the loop. We’ve seen some pretty bad situations
where beneficiaries have no idea that money’s coming to them and they haven’t. Most people that accumulate this
type of net worth, they’ve worked really hard to do it and there’s certain values and work ethic and things that they
have endured to be able to do that. And hopefully it’s passed on to the kids.
Speaker 1 – 22:07
But if the kids haven’t gone through that and they all sudden give money at one time, it can be a disaster. So
include your beneficiaries and children in these conversations and just make sure it’s done appropriately.
Speaker 2 – 22:16
Well, James said, thanks for ending that and thanks for watching guys. And subscribe for more content.
Meeting Title: Why the IRS Shouldn’t Be Your