Now is a Good Time to Accelerate Estate Planning by Jeffrey M. Mutnik, CPA/PFS

Posted on March 16, 2020

Global equity markets declined dramatically on March 12, as fear and uncertainty surrounding the novel coronavirus (COVID-19) pandemic continued to mount. U.S. stocks took their biggest single-day drop since 1987, bringing the country’s longest economic expansion in history to a screeching halt. Whether the financial damage to investors’ portfolios will continue is unknown.

Yet, based on the information available to us at this time, the negative impact of market volatility, combined with record-low interest rates, has created some unique estate-planning opportunities investors should consider to protect wealth and preserve future asset appreciation for beneficiaries.

Intrafamily wealth transfers have always been a popular method for high-net-worth individuals to protect assets from creditors, facilitate succession plans and reduce exposure to estate and gift tax. While it is true that the current estate tax exemption of $11.58 million for individuals ($23.16 million for married couples filing jointly) eliminates estate tax concerns for most families, this generous exclusion amount is temporary; it is scheduled to be cut in half in 2026, but that reduction may occur sooner and may possibly fall even lower depending on the results of the upcoming elections. Taxpayers should take the time to consider if it makes sense to transfer some assets outside of their estates now, before the exemption changes and before they pass away. The specific strategies individuals choose to reduce their taxable estates today will depend on a variety of economic indicators and market conditions framed by the own unique circumstances and needs.

In the current environment with investable securities 25 to 30 percent off recent highs, and interest rates near zero, wealth planning may involve the use of a variety of different trusts, intrafamily loans, family limited partnership (FLPs), or a combination of all these strategies. For purposes of this article let’s focus on FLPs.

A transfer of assets into an FLP does not remove them from an individual’s taxable estate, but it does change the structure of how those assets are owned. Consequently, the FLP’s limited partnership (LP) interests are made to be worth less than the proportionate value of the partnership’s underlying assets. The limitations that cause partnership interests to be “limited” preclude LPs from liquidating the underlying assets and taking cash distributions. Therefore, a discount is usually applied to arrive at the fair market value of such an LP interest.  The size of the discount will depend on several factors, including the types and scopes of limitations placed on the LPs in the partnership’s operating agreement as well as the type of assets owned by the FLP.  Most reasonable discounts land between 25 percent and 35 percent.

For some taxpayers, achieving this discount is their primary goal. Senior family members may gift LP interests to future generations at this lower value, removing them and any future appreciation from their taxable estates. This can be an excellent use of the enhanced exemption limit currently in effect, especially when considering the government’s reassurance that it will not claw back any tax-free gifts made today to an individual’s taxable estate in the future.

Other taxpayers who wish to keep the value of the assets in their estates, but not the future appreciation, can sell their LP interest to a trust for a promissory note. This will “freeze” the value in the taxable estate, and taxpayers would collect interest annually at the historically low Applicable Federal Rate set by the IRS each month. The lower the interest rate, the less cash grantors will collect, thereby lowering the value of their taxable estates when they die.

To put this strategy into practice, consider that Mr. and Mrs. Smith have a taxable estate valued at $35 million. Just one month ago, the Smith’s investment portfolio of marketable securities was valued at $10 million. Following recent market volatility, the value of that portfolio has decreased to $7 million. If the Smith’s transfer those depreciated investments to an FLP and take back one or two limited partnership interests today, they effectively change the title of the assets they own. Presuming a 30 percent discount is warranted for their LP interest(s), the Smith’s can remove an additional $2.1 million from their combined taxable estate. Their assets currently valued at $7 million (previously $10 million) would be worth $4.9 million. By gifting discounted FLP limited interests to their children and grandchildren, family matriarchs and patriarchs can further reduce their exposure to transfer taxes while preserving the underlying value of those investments and their future appreciation for family members. Therefore, if the value of partnership interest gifted to the Smith’s children and grandchildren increases in 10 years, all subsequent appreciation will be excluded from the Smith’s taxable estate.

Alternatively, if the Smith’s desire the cash flow of the interest payments, they may instead sell the combined LP interest to a grantor trust created to benefit their descendants. They may not be sure their estates will pay estate tax, as they have planned to use or give away much of their wealth during their lifetimes. A sale to a grantor trust may be preferable to avoid reporting any gain on such sale, since the grantor trust is treated as the taxpayer for income-tax purposes. Another key benefit of this strategy in today’s record-low interest-rate environment is that when the markets do rebound, trust assets will appreciate at a rate much higher than the interest on the promissory note and pass to family members transfer-tax free.

We may not be able to control the markets, but we do have opportunities to engage in tax-efficient wealth planning and preserve generational wealth while also mitigating risks of exposure to future changes in the tax code. Now is a good time to meet with accountants and financial advisors to assess your current estate plans and implement strategies that can allow you to leverage market conditions to achieve your specific goals.

About the Author: Jeffrey M. Mutnik, CPA/PFS, is a director of Taxation and Financial Services with Berkowitz Pollack Brant Advisors + CPAs, where he provides tax- and estate-planning counsel to high-net-worth families, closely held businesses and professional services firms. He can be reached at the CPA firm’s Ft. Lauderdale, Fla., office at (954) 712-7000 or via email at