Private Client Services: Individual Tax Planning

When comparing individual tax brackets and rates to those of trusts and estates, it’s apparent that trusts and estates reach the highest tax rates much quicker than individuals. Careful consideration should be paid to whether a distribution of income from an estate or a complex trust to a beneficiary would result in less total tax paid on the same income taxed at the individual level versus the estate or trust level. Distributions of income in this scenario would shift the income from being taxed on the estate or trust’s tax return to the individual tax return of the beneficiary receiving the distribution. If the beneficiary is in a lower tax bracket than the trust, this would result in overall tax savings.

Another planning opportunity surrounding trust distributions is utilization of the 65-day election under Section 663(b). This annual election allows a trust an additional 65 days after yearend to pay distributions to beneficiaries and report those distributions on the prior year’s tax return. This flexibility provides the opportunity to distribute the exact amount of income needed to optimize tax savings and can be paired with the point above regarding the tax brackets and rates to achieve the most favorable outcome for trusts and estates and their beneficiaries.

It’s important to note that the above strategies surrounding distributions apply to trusts that are taxed as complex trusts. Not all trusts are taxed as complex trusts – many estate plans incorporate irrevocable trusts taxed as grantor trusts, which offer the grantor the ability to be the owner of trust assets for income tax purposes but not for estate tax purposes. In this case, distributions would not carry out taxable income when paid to beneficiaries. For the reasons above and perhaps others (such as the grantor’s liquidity), it may be worth exploring whether a trust currently taxed as a grantor trust can be taxed as a complex trust in future years to take advantage of these planning opportunities.

Estate tax continues to be a hot topic as the lifetime exemption continues to rise with inflation adjustments and is set to decrease in 2026.

Other strategies that do not use any gift/estate tax exemption are the direct payment of tuition and medical expenses and gifts to your spouse. Tuition and medical expense payments are not treated as a taxable gift and do not use any of your lifetime exemption amount as long as the payments are made directly to the educational or healthcare institution. These can be made on anyone’s behalf and are not limited to immediate family members. Additionally, gifts to a spouse, assuming you are both U.S. citizens, qualify for the unlimited marital deduction and are not subject to gift tax.

For those worried about giving away too much, Spousal Lifetime Access Trusts (SLATs) are worth considering. SLATs have become popular over the past few years due to their flexible terms and the increased lifetime exemption amounts. SLATs allow a donor-spouse to use a significant portion of their exemption by transferring assets to a trust while maintaining indirect access to the assets transferred through the beneficiary-spouse.

Inflation and interest rates affect so many aspects of our lives – groceries, mortgages, business loans, and so forth – and we often forget that they affect our estate planning strategies as well. When the Federal Reserve increases the fed funds rate, there are usually increases to other rates, including the applicable federal rates (AFRs) and the section 7520 rate (the GRAT hurdle rate), both of which are integral parts of estate planning.

When interest rates are elevated, even slightly, we look for silver linings. Interest rate changes are particularly relevant for estate planning techniques that involve split gifts, like those made to qualified personal residence trusts (QPRTs), charitable remainder trusts (CRTs), and grantor retained annuity trusts (GRATs), as well as for more straight-forward transactions like intra-family loans. The popularity of split gifts in these environments is a product of the way a gift’s value is calculated, which is by taking the fair market value of the gift and subtracting the retained interest. In a high-interest rate environment, the value of the taxable gift is further reduced. If the taxable gift is lower, less exemption is used when making the gift.

With QPRTs, you transfer your home into a trust, retain the right to live in it for a specified period of time, and then gift that property to designated beneficiaries (usually children/family members) at the end of the QPRT term. Each piece of that split-interest gift is valued at the time the transfer is made. A higher interest rate means the value of the retained interest to live in the home is higher, which means that by default, the value of the remaining interest, or taxable gift, is lower. This is a tax-efficient way to keep a home in the family for generations.

Two important points surrounding QPRTs are choosing the appropriate term during which you retain the right to remain in the home, and whether you remain in the home after it passes to your beneficiaries. Should you pass away during the QPRT term, the value of the home is brought back into your estate, so careful consideration should be paid to how many years you choose for the QPRT term. You may also continue living in the home after it passes to your beneficiaries, but fair market value rent must be paid to the beneficiaries from that point on. Keep in mind that the payment of rent will remove assets from your gross estate.

With CRTs, you establish an income stream to a beneficiary for a defined period, followed by a gift to charity. The charitable deduction — the second part of the gift — is equal to the present value of the remainder interest passing to charity, meaning that the higher the interest rates, the higher the charitable deduction, which is a positive outcome for income tax purposes. It’s best to use low-basis assets with CRTs because you won’t recognize gain on the contribution, but the full fair market value will be used to compute the value of the income interest and the charitable deduction.

Other useful strategies in rising rate environments include intrafamily loans and GRATs. These may also appeal to those who have used a significant portion of their lifetime exemption. With intrafamily loans, you make a loan to a family member using the AFRs set forth by the IRS. While AFRs are high, they’re typically lower than average mortgage rates, for example, so if you have a family member who needs liquidity, this could be a good solution.

GRATs are used to transfer appreciation in assets to named beneficiaries without the imposition of gift tax. They are particularly relevant for those who have used up their exemption amounts and are looking to transfer more wealth out of their estate. The grantor transfers an asset into a GRAT while retaining an annuity interest for a period of time, and to the extent that asset appreciates in value over the Sec. 7520 hurdle rate during that period, that appreciation passes to your beneficiaries gift tax-free. A common GRAT strategy is to establish short-term, rolling GRATs to mitigate mortality risks and avoid adverse effects of fluctuations in the GRAT asset values.

Another strategy for those that may not have much of their lifetime exemption remaining is a sale to an intentionally defective grantor trust. This works much like a GRAT in that it’s a freezing technique where an appreciating asset is sold at the then-fair-market value to an irrevocable trust in exchange for an installment note. This becomes a transaction that is disregarded for income tax purposes and removes the future appreciation on the asset from the seller’s estate at minimal or even no gift tax cost. Typically, there is a “seed” gift to fund the trust up front of at least 10 percent of the sales price should the trust not have liquidity to facilitate the note.

Recent changes involving retirement plan accounts within an estate plan are significant enough that you may want to review your estate plan to be sure beneficiary designations still reflect the intended income tax consequences, especially if the account is left to a trust. The income tax consequences of these accounts may vary depending on the type of account and the type of designated beneficiary.

It is crucial to understand how these assets will be taxed for the recipient, especially when the recipient is a trust. The age of the decedent and the type of beneficiary (e.g., surviving spouse, trust, charity, etc.) will affect how quickly the accounts must be liquidated, and therefore taxed, when in the hands of the beneficiary.

Certain inherited accounts will need to be fully depleted after 10 years, so timing and planning for these distributions for income tax and cash flow purposes is pivotal.

The estate and income tax consequences of these retirement accounts can make them an ideal asset to leave to a charity if you are charitably inclined. This shifts the income tax burden away from both your estate and your heirs to an entity not subject to income taxes.

Roth conversions have also become increasingly popular as the tax law has grown in complexity for these assets. A Roth conversion allows the taxpayer to convert a pre-tax account to an after-tax account so that the income tax liability is generated by the taxpayer before death. This strategy avoids income tax consequences for the estate or beneficiary and the payment of the tax by the taxpayer reduces their gross estate.

There are a few things to keep in mind for retirement planning at year-end. RMDs, which begin at age 73 (except for Roth IRAs), are one consideration. There is a complex set of rules around when distributions from inherited IRAs must be taken, so beneficiaries should work with their Withum Wealth planners for the correct guidance.

RMDs are classified as ordinary income and can push individuals into a higher tax bracket for a particular calendar year. Those who do not need the income may consider making a qualified charitable distribution from their IRA. This allows charitably inclined individuals to direct up to $105,000 from their IRA each year (at age 70½ and older) to a public charity, reducing the RMD — and thus, taxable income — by that amount.

In 2024, the maximum amount that can be contributed to an employer-sponsored plan is $23,000, with a $7,500 catch-up contribution for those 50 and older. Beginning in 2025, there will be a special catch-up for those aged 60 to 63 for the greater of $10,000 or 150% of the regular catch-up amount in effect for the taxable year that is indexed for inflation.

For IRAs, the contribution limit for 2024 is $7,000, with a $1,000 catch-up contribution for those 50 and older. The deadline for 2024 IRA contributions is April 15, 2025. The contribution limit for 2025 remains the same — $7,000 per person with a $1,000 catchup contribution for those 50 and older.

Disclaimer: No action should be taken without advice from a member of Withum’s Tax Services Team because tax law changes frequently, which can have a significant impact on this guide and your specific planning possibilities.