By: Andrew J. Kelleher and Edwin P. Morrow, Kelleher + Holland, LLC
When it comes to protecting your wealth from taxes, think of it like catching the savory wave. If you’ve got significant assets and want to avoid a heavy tax hit, it’s time to consider SURFing—Step Up Rescue Financing. Here’s a little dose of tax planning education.
Riding the Estate Tax Wave
If you are successful enough to be concerned about estate taxes, you’ve likely heard that gifting assets during your lifetime can reduce the taxes your estate will owe later. But you don’t want to just paddle out without a plan. Using an irrevocable grantor trust is like choosing the right board for the conditions—it keeps your assets secure from creditors and divorce, and lets you keep paying the taxes on the trust without it counting as another gift. This strategy can help you ride the estate tax wave smoothly.
The Risk of a Tax Wipeout
However, even the best surfers know there’s always a risk of wiping out. One downside of irrevocable trusts is that they can cause you to miss out on a valuable tax benefit known as the “step up in basis.” Imagine this scenario: You put $500,000 worth of stock into the trust, and by the time you’ve finished riding life’s waves, that stock has swelled to $3 million. The good news is that this growth isn’t hit hard by estate taxes, potentially saving you around $1 million. The bad news? If your heirs sell that stock, they could face a $750,000 capital gains tax—an expensive wipeout.
If you had held onto the stock until your final wave, the value would have stepped up to $3 million, meaning your heirs could have sold it without any capital gains tax—like catching the perfect wave without a single drop.
Getting the Best of Both Worlds
But don’t let that scare you off your board—there’s a way to enjoy the benefits of both estate tax savings and the step up in basis. Savvy tax lawyers can help you navigate these waters. Before you take your final ride, you can swap out high-basis assets (like cash) for the low-basis assets in the trust. This swap is smooth and tax-free, allowing those low-basis assets to be included in your estate at your passing. When that happens, those assets will receive the step up in basis, reducing or even eliminating potential capital gains taxes.
SURF’s Up: A Strategic Move
What if you don’t have enough high-basis assets or cash to make the swap? This is where the SURF plan comes into play. Think of it as your strategic backup—setting up a line of credit with a bank or financial situation that you can draw on if your health takes a turn. This isn’t always easy, especially if most of your assets are tied up in things like real estate or a business. But with the right agreements in place, your lender might allow you to ride this wave with confidence.
The Payoff: Tax Savings on the Horizon
Setting up a SURF plan might take some time, but the rewards can be significant. For example, one savvy individual borrowed $20 million to buy $26 million worth of low-basis assets from their trust. When they passed away, those assets got a step up in basis to $26 million, saving the family about $5.4 million in capital gains taxes. The cost of the loan? Just a small price compared to the massive tax savings—like catching the wave of a lifetime.
Stay Ahead of the Break
So don’t let tax concerns pull you under just because your assets are in an irrevocable grantor trust. With the right planning and strategies like SURF, you can navigate the waves of estate and income tax savings and ride them all the way to the shore. The surf’s up, and it’s time to catch that financial wave!
Andy Kelleher is co-founder of Kelleher + Holland, LLC and Ed Morrow is the firm’s Estate Planning and Estate + Trust Administration Co-Chair. K+H is a nationally recognized, full-service law firm with 60+ legal professionals headquartered in North Barrington. They can be reached at [email protected] and [email protected] .