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Inheritance taxes: the toolbox for effective planning

No day is without news on new taxes. While we don't claim to predict the future, in light of the taxman's recent focus on easy to collect taxes, the chance of increasing gift and inheritance taxes is obvious. Both taxes apply to transfers of wealth without reward either during lifetime or with the wealth owner's decease.

The call to action

 

So, if you have not been doing it thus far, this is the moment to assess your estate's inheritance tax exposure and implement a tax planning strategy. The topic is complex, and each situation requires an in-depth and expert analysis of all circumstances.

Legitimate inheritance tax planning

 

We want to stress that this is not a field for testing new inheritance tax planning approaches - you should rely only on proven and legitimate strategies that your specific tax environment allows. We also advocate for keeping things simple to ensure straightforward tax administration.

To help, read on for our overview of tools and techniques that may add value when assessing your particular opportunities for inheritance tax planning.

Some background information on inheritance taxes 

 

According to the OECD 2021 Inheritance Tax Policy Study, on average across the OECD, 0.36% of total tax revenues are sourced from gift, estate, and inheritance taxes. Among countries that levy gift, estate, and inheritance taxes, 0.51% of total tax revenues, on average, are sourced from these taxes.

Good news

 

Interestingly, most estates are not subject to inheritance or estate taxes, mainly due to exemptions. The shares of estates subject to inheritance taxes range from 0.2% (United States) to 48% (Belgium, Brussels).

No room for negligence

 

While gift, estate, and inheritance taxes are generally minor sources of tax revenue, they support objectives beyond raising revenue, such as redistribution of wealth. Although tax policymakers argue that inheritance taxes are a good way to reduce inequality due to inherited wealth, they are widely perceived as unfair taxes.

24 of 36 OECD countries levy wealth transfer taxes. Austria, Czech Republic, Norway, Slovak Republic, Sweden, Israel, New Zealand, Australia, Canada, Estonia, and Latvia do not have estate and inheritance taxes.

Since, for your situation, inheritance taxes may play an important role, let's focus on inheritance tax planning opportunities.

Start with a review

 

With no estate plan in place, you should start preparing a comprehensive and detailed overview of your wealth. This sounds straightforward, but in our experience, a detailed inventory is often missing. The same holds for classification according to asset classes and all sources of wealth and income.

The groundwork

 

If you already have an estate plan, you should review all assets, values, and assumptions made in the past. Since this post is about tax planning tools, we invite you to check our previous posts on beginning estate planning and cross-border estate taxation to complete the picture.

For this guide, we take it that the groundwork has been performed and that your estate plan's beneficiaries and their inheritance taxes exposure have been clarified.

How to approach planning for inheritance taxes

 

Let us stress a point here: the OECD and your taxman are perfectly aware of the following opportunities to plan for inheritance taxes. In particular, the latter has a specific focus on the distinction between tax planning and tax avoidance.

Legitimate inheritance tax planning

 

Tax planning is not happening merely along with the law's wording but in light of the legislator’s intention and the purpose of tax laws. Even if your plans to reduce inheritance taxes are strictly legal, your taxman will be armed with specific anti-avoidance rules to enforce the tax laws' intent and purpose. It can be tempting to explore loopholes, but this is a level playing field, and the wrong approach can become expensive.    

Exemptions and allowances

 

Many jurisdictions offer exemptions or allowances up to a certain amount not subject to inheritance taxes. This is an opportunity to leverage. Exemptions often apply for spouses and children only, and thorough planning also understands which assets will form part of your estate.

Specific tools we cover may allow you to dispose of assets in a way that they are not considered part of your estate anymore to leverage exemptions and allowances. Some jurisdictions exempt certain assets such as family homes or family businesses from inheritance taxes if transferred within the family.

Family businesses

 

Family businesses are often an important economic sector and large employers. Exemptions avoid liquidity pressures to meet inheritance taxes duties and ensure business continuity. In particular, small and medium enterprises with constraints in accessing credit markets would otherwise face liquidity issues due to wealth transfers.

Family homes

 

Family homes are often exempt for similar reasons to protect family wealth without running the risk for forced sales to cover inheritance taxes.

Further allowances

 

There may be additional allowances for art, libraries, archives with public interests, and other scientific collections. Understanding exemptions and allowances early in the process is essential to define and capitalize on your strategy.

Lifetime gifts

 

Giving during your lifetime can reduce your taxable estate significantly. As with inheritance taxes, often there are exemptions and allowances for gifts to reduce the tax burden. Again, an understanding of the tax implications and early planning will allow you to reduce the taxable estate steadily.

Annual allowances

 

Your tax system may allow tax-exempt yearly gifts that, while small, can accumulate to a considerable tax benefit over the years. Early planning is critical since many jurisdictions recharacterize gifts made shortly before the donor's decease as inheritance and apply inheritance taxes. Transferring wealth early, particularly if you hold a significant portion of liquid assets that exceed your retirement needs, can lead to a considerable reduction of inheritance taxes.

Record-keeping

 

It's essential to keep a record of all donations, and you should be careful in retaining any interest in gifted assets since the exemption may not apply in such an event.

Trusts and foundations

 

In addition to efficient estate planning by avoiding lengthy probate procedures, trusts and foundations can also offer inheritance tax planning opportunities.

Depending on the jurisdiction, transfers may be subject to gift and inheritance taxes, but distributions to beneficiaries may be exempt. There could also be tax deferrals available, and taxes paid tomorrow are better than those born today.

The type of structure, revocable or irrevocable, can lead to other taxation types than inheritance taxes with favorable results for both the wealth owner and the beneficiaries. 

In particular, if your tax system has clear rules for ongoing taxation and inheritance taxes for trusts and foundations, they can enhance your estate planning strategy in many aspects.

Focus on estate planning

 

We don't recommend using trusts or foundations for mere tax optimization since they are tools for long-term holding and passing on wealth, and tax laws may change over time. Suppose the tax treatment is neutral, i.e., neither encouraging nor discouraging to use trusts or foundations. In that case, this is an excellent starting point to achieve many other estate planning benefits at no additional tax cost. 

Asset consolidation, generational wealth protection, streamlined generational wealth transfer, and privacy are some advantages of trusts and foundations that may outweigh considerations over reducing inheritance taxes.

Family investment companies

 

Often, with dedicated family investment companies, you can achieve similar results and a preferential inheritance tax treatment. In recent years, family investment companies have become popular to pass wealth to future generations in a tax-efficient way.

How family investment companies work

 

Shareholders are family members or sometimes family trusts with different rights attached to the shares according to the age or generation of the shareholders. The company is holding real estate or shares but usually not performing trading activities.

A legitimate inheritance planning approach

 

It's an entirely legitimate planning strategy for generational wealth transfer and mitigation of inheritance taxes. Even some tax authorities such as the UK HMRC look at them as business as usual rather than suggesting a correlation between the family investment company and non-compliant behaviors.

Sale of assets to a trust or foundation

 

Although it requires thorough planning, the aim is to keep this simple: instead of contributing, income-producing assets can be sold to a trust or foundation.

How it works

 

The seller grants the vehicle an interest-bearing loan to be paid back within a specific period. While a contribution may trigger gift or inheritance taxes, in some instances, the sale to the trust or foundation where the seller is not a beneficiary is not subject to such tax. As an additional benefit, this technique can allow for the asset's multigenerational holding to benefit the beneficiaries who retain the income.

Such a strategy can be efficient for income-producing real estate, and with the current low interest rates, the cost of acquisition for the real estate remains modest.

The caveat

 

Again, all circumstances need to be considered for such a strategy, and tax efficiency should not be the primary driver for selling or contributing assets to a trust or foundation.

Life Insurance for liquidity planning

 

Inheritance tax planning is also liquidity planning. Suppose you mainly leave unlisted shares and real estate and the beneficiaries have to pay inheritance tax.

Tight liquidity situations due to inheritance taxes

 

In that case, they may run into a tight liquidity position and have to sell assets to settle the inheritance taxes bill. This is where life insurance with a death benefit in the range of the expected inheritance taxes can cover it.

A life insurance policy may still be part of the taxable estate, and that's why holding it under a trust or foundation can be a tax-efficient solution in some jurisdictions.

A variety of options

 

You can choose from various products, single or recurring premium payments, premium financing options, and possible underlying assets that fit best into your overall strategy. Besides, with a life insurance policy, you can keep things simple and streamline the succession process.  

Charitable donations

 

Finally, charity gifts are exempt from gift and inheritance taxes in many jurisdictions. They are often also deductible to reduce your taxable income: a win-win between doing good and saving taxes. And you may even avoid capital gains taxation with charitable donations.

Another caveat 

 

It would be best if you genuinely donated to charity since your taxman has an eye on the overvaluation of non-pecuniar gifts, donations in which you retain an economic interest, and payments for goods and services disguised as donations.

Some more inheritance tax planning techniques

 

While we've outlined the key tools to consider when planning your inheritance taxes position, there are some other approaches to consider.

Bare ownership and usufruct

 

Firstly, keeping the usufruct during your lifetime while transferring ownership of specific assets directly can be an efficient inheritance tax planning technique.

Limited partnerships

 

Depending on your tax jurisdiction, the same may work with limited partnerships within family members that may allow you to control the held assets.

Unrealized capital gains

 

You may also want to consider the appreciation of specific assets and their favorable tax treatment in the event of a transfer. Unrealized capital gains require specific attention. They can be taxed at death, passed to heirs on a carry-over basis, or exempt upon death and transferred to beneficiaries with a step-upped to market value.

Depending on your tax system, you may plan for realizing capital gains to reduce inheritance taxes. Again, be aware of specific anti-avoidance rules that may prevent such arrangements from reducing inheritance taxes.

Spending excess income

 

Spending excess income is probably the most simple and straightforward option from a tax perspective, and as long as you can maintain your lifestyle, it could be fun.

Relocation

 

Also, perhaps consider changing your residence to a more favorable tax jurisdiction. However, moving your residence to reduce inheritance taxes is a perfect example of the application of anti-avoidance rules. In many jurisdictions, taxpayers remain subject to inheritance taxes for several years after expatriation to tackle tax avoidance. 

Further opportunities

 

The list of inheritance tax planning techniques goes on with intra-family loans, tailored pension schemes, specific trust and foundation schemes, and structuring assets under other vehicles to make the most out of your inheritance tax system.

Choose estate planning over inheritance tax planning

 

One crucial reminder: how you structure your wealth should not be mainly driven by tax considerations but by your family's needs. Inheritance tax planning opportunities are tremendous, but they should always align with your family's purpose of wealth and your estate planning strategy.

That’s why we advocate for a holistic view of your estate planning arrangement to ensure wealth preservation over generations in the best interest of the beneficiaries.

If the ideal wealth transfer comes at the cost of inheritance taxes, it can still be better than an exempted transfer that does not fit your estate planning strategy and could put wealth preservation at risk.   

Conclusion on inheritance taxes

 

Since we are lawyers, please allow us to sum up with a disclaimer here: this is not tax advice. We only intend to provide you with an overview of legitimate inheritance tax planning tools, which is not exhaustive.

Focus on legitimate inheritance tax planning techniques

 

Each situation is unique, and this is not a field for testing any new approaches but to rely on what your tax system allows. Quite often, it will enable for tax-efficient transferring wealth within your family. 

Estate planning is the top priority

 

Furthermore, to ensure generational wealth protection, estate planning should not be driven by mere tax considerations to reduce inheritance taxes. In our view, this rarely leads to an alignment with wealth preservation over generations in the family's best interest.

Keeping things simple

 

What we can say is that in our experience, keeping things simple is essential. We advise diversifying and looking at the big picture. 

A variety of straightforward tools and stringent approaches orchestrated in a comprehensive estate and inheritance tax planning strategy will ensure lasting and efficient results.

Things may change over time

 

Finally, it would be best if you kept in mind that tax laws may change over time. Thus you are planning for an uncertain future, and you may probably not achieve and quite certainly not experience the perfect outcome but hopefully achieve peace of mind.

When to start? Now!

 

The most important message we want to leave you with is that whatever stage in your life you are at, don't put your plans off but start with with estate planning immediately and tackle inheritance taxes along the way. Otherwise, you may miss out on significant opportunities.

Updated 06-11-2021

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