Financial Planning: Trust and Estate

Trust and Estates:

By Christopher Chiu, CFA

When James Gandolfini passed away in 2013, he left a sizable estate worth some $70 million, much of it grown in the later part of his life. This was a likely result of his breakout role playing Tony Soprano, as he finally found success in the later part of his life.  Success, even delayed success, is welcome but it can also create problems. It’s not good when your success outstrips your capacity to protect that success. And unfortunately, Gandolfini had not set up a plan to shield his estate from the estate tax. As a result, the IRS collected close to $30 million of the $70 million estate before it was passed on to his family. 

So what can people do? Create a plan. There is no sense in trying to avoid complication when you have wealth. Transferring large amounts of wealth is going to involve complication, either for you, or for those taking care of your estate after you. And it’s better to create a plan for such matters when time is available.

Reason for setting up a trust: Avoid estate tax

If you are going to have a large estate, one such possible plan of action involves setting up a trust. One of the main reasons to set up a trust is to avoid estate tax. Estate tax is the tax which the estate will incur when passing on its assets to the inheritors. The federal taxation rate for estate tax starts at 18% and goes as high as 40%, depending on the size of the assets transferred.

The estate tax rules become triggered once you file a file a tax return on the deceased person, which includes an estate tax return. The estate tax return will include the value of the inherited property, business, or other assets at the fair market value, not at the price at which they were initially bought. This is an important distinction to understand, as many people may inadvertently underestimate the value of their own wealth and therefore their tax liability.  So be attentive to the IRS rules on this. (The IRS audits about 50% of all estates valued at $5 million or more, 25% of estates from $1 million to $5 million.) It’s their job to verify and collect this estate tax if it is applicable.

But what if it’s just my family property and my family business? For example, what if I’m just a farmer running my family farm?

As I said earlier, life’s complications will come for you whether you want to avoid them or not. Even if you live a basic life without a lot of liquidity, it doesn’t make you immune from estate tax if your assets have appreciated in value and reach the threshold of the estate tax. Depending on the value of the land at issue, the fair market value of appreciated farmland might result in an estate tax so high that the inheritors managing the estate could find themselves in a position of having to liquidate farm assets in order to cover the tax liability. Again, this can be avoided through a trust, as the trust will be the owner of the assets and no legal transfer will have taken place to trigger a tax event.

Another reason for setting up a trust: Avoiding probate court and family squabbles

Now, you don’t necessarily have to worry about setting up a trust if you don’t need to shield it from estate tax. In fact, if your estate is less than $13.6 million (the threshold in 2024), it will not incur a federal estate tax. However, it may still incur a state estate tax, as the threshold for each state is different and may be lower than the federal threshold.) If your state estate tax threshold is below the federal threshold you may still think about setting up a trust to avoid the state estate tax and for other reasons.

You may also set up a trust to avoid probate court. Probate court is necessary when there is no will or trust to limit disputes between descendants or relations. These disputes will require the probate court to settle them.  Trusts can limit disputes and time spent in probate court among family members, relations, or anyone who thinks they have a claim on the estate’s assets. It doesn’t even need to be complicated but a simple structure like a trust could determine in advance how the estate plans to pass on its assets.

Alternatives to trusts: the LLC 

Some people have also considered setting up an LLC, if not to avoid the estate tax, then at least to transfer their assets at a discount of their present worth to the inheritors. For example, in the state of Illinois an LLC transferred assets receive a valuation discount of up to 40 percent of the market value. This is true in some other states as well. An LLC is essentially a partnership that can be established as a separate entity which, like a trust, holds the assets. 

Where does RCM Wealth Advisors fit in?

I have listed just some of the possible considerations and complications involved in wealth transfer. If you have further questions, it’s best to reach out to your financial advisor who can work with a trust attorney to consider possible solutions.