By: Kemp Moyer and Sachi Danish, BPM LLP
For owner-operators of wineries and other closely held businesses, now may be an opportune time to maximize estate planning through the utilization of gifts of ownership interests. The Tax Cuts and Jobs Act (TCJA) of 2017 has been broadly seen as favorable to businesses, high-net-worth individuals and estates, including the temporary doubling of the lifetime federal exemption for gift, estate and generation-skipping taxes, which stands at $11.7 million in 2021.
However, the combination of a new administration, as well as increasing federal deficits in the wake of the COVID-19 pandemic fallout and federal response, means the higher lifetime exemption may be in jeopardy. Many in the tax policy and preparation communities are expecting the recently elected Congress and administration to accelerate the rollback of the exemption increase. Sweeping changes have been proposed by the Biden administration and now it is widely considered just a matter of when and how much. Among the potential early targets is the larger estate tax exemption, which will sunset back to pre-TCJA baselines at the end of 2025 without further action from Congress.
Estate and Gift Tax Law
As noted previously, the current gift, estate and generating skipping tax (GST) exemption amount is approximately $11.7 million per individual. This exemption amount is currently required under the law to be cut by 50% in 2026, to about $6 million per person, depending on adjustments made for inflation. This reduction is built into current law, and it has created a use-it or lose-it opportunity for high-net-worth individuals. However, the following Biden proposals are even more dramatic:
• Reduce the estate and GST exemption to $3.5 million and only permit $1 million in tax-free lifetime gifts.
• Increase the estate tax rate significantly from 40% up to a 65% top rate.
• Eliminate the stepped-up basis rules at death. This would be a significant change as a carryover basis may create an income tax at death (“death tax”) or upon later sale on all appreciated property.
• Limit valuation discounts between family members.
• Include grantor trusts in the grantor’s estate and eliminate use of short-term grantor retained annuity trusts (GRATs) and sales to intentionally defective grantor trusts (IDGTs).
• Limit duration of GST trusts.
The above proposals make it urgent to address your estate tax planning now, rather than waiting for what the future may bring, although planners must also consider the possibility of retroactive law changes.
Some estate and gift opportunities to consider under current law include:
• Use your annual exclusion gifts of up to $15,000 per person ($30,000 if both parents make gifts to that individual). Over time, these gifts can accumulate into significant amounts. These amounts could be on top of direct payments to a provider for medical services or educational tuition for anyone, related or not, which are not considered gifts.
• Make large gifts of assets with potentially depressed values and subject to discounts. Leverage the current $11.7 million unified credit amount with gifts of fractional interests in real property or ownership interests in a family or closely held business that qualify for valuation discounts. To protect against retroactive changes to the $11.7 million gift exemption amount planners should also consider use of disclaimers, formula gifts, and lifetime qualified terminal interest property (QTIP) trust elections as part of the planning with trusts.
• Make low-interest loans to children. Loans for homes or business opportunities are often very attractive, with August 2021’s Applicable Federal Rates (AFRs) at .19% for loans three years or less, 1.00% for loans more than three years and not more than nine years, and 1.87% for loans more than nine years.
• Gifts and sales to intentionally defective grantor trusts (IDGTs) can be used to transfer cash, securities, business interests, real property and other investment assets to descendants in a tax-beneficial manner. The sale or gift of assets from the parents or grantors to an IDGT is not subject to income tax, because the grantors are treated as having sold the assets to themselves. Only gift tax is due on the transfer. Assets transferred to the IDGT remain in the trust and grow outside the grantor’s estate, allowing them to appreciate tax-free.
Owner-operators of successful businesses likely already have some familiarity with the estate tax. This tax works in conjunction with the federal gift tax, which applies to transfers of property during one’s lifetime. In theory, both estate transfers and gifts made during one’s lifetime are currently taxed at a maximum marginal rate of 40%.
The gift tax annual exclusion allows individuals to gift up to $15,000 per recipient per year tax-free. The lifetime gift tax exemption currently stands at $11.7 million, and this maximum amount represents the sum of all taxable gift, estate, and generation-skipping giving allowed before taxes are due. The temporary nature of the current higher lifetime exemption has created a level of urgency in many estate strategies.
There are proposals in Congress to reduce the estate and GST tax exemption to $3.5 million and the gift tax exemption to $1 million, limit valuation discounts for family businesses, and trigger income tax when gifts and transfers of appreciated property exceed $1 million. Political analysts expect these proposals to be among the Democrats’ top priorities, not to just increase taxes but to redistribute wealth in our country. This puts some pressure on larger estates that may be affected, including many winery owners. To utilize the higher lifetime exemption before it expires, many high-net-worth individuals are acting urgently to accelerate their estate planning strategies to avoid a much greater potential estate tax burden.
Winery Ownership Estate Planning
Even in an increasingly corporatized wine space, many wineries continue to be family-owned businesses. Many owners of closely held wineries, desiring to keep their legacy in the family, already intend to pass down the business upon their death to their children or other inheritors. The increasing likelihood of a rollback on the lifetime exemption means winery owners may want to consider transferring at least some portion of their business in the near future via gifts, or sales to IDGTs rather than waiting until death. Gifts and sales of appreciated assets may trigger immediate to grantor trusts are
While certain wine industry segments have recovered to or even exceeded their pre-COVID sales, many closely held wineries are experiencing challenges such as reduced tasting room visits and lower sales to restaurant customers due to COVID-19, which often contributes to a lower business valuation. A lower valuation means a smaller gift in the eyes of the IRS, and less estate taxes or even avoiding them altogether.
The benefits of any reduction in business value due to the pandemic and the availability of the favorable tax rules related to grantor trusts may not be here for long. This is a unique opportunity for winery owners to take care of what they were already planning to do down the line, while taking advantage of historically favorable tax conditions. Estate planning is a process, not a one-time trust agreement, and as you become more educated in the process through your trusted advisors including your attorney, accountant, wealth and insurance advisors, your ability to make the key decisions in the process will become easier.
Kemp Moyer is Certified Valuation Analyst and a Director in the Advisory practice leading the Firm’s Valuations and Appraisals team at BPM LLP.
Sachi Danish is a Director in Tax Private Client Services and leads the Estate & Trust practice for BPM.