Why donating now can save on future property taxes

The provisions of the Tax Cuts and Jobs Act (TCJA) are due to expire in 2025, and while the implications for individual estates are a priority, private equity professionals also have a lot to consider as the deadline approaches.

With the market downturn we’ve all experienced so far in 2022, it’s counterintuitive to think now is the optimal time to make major gifts from your estate. Why donate assets when they have already taken a hit on their portfolio? The answer is twofold.

First, the ability to transfer discounted assets to another entity (trust or family member) given the current market environment allows for the recovery and subsequent growth of those assets outside of your estate. This is especially powerful for people whose total net worth is already in estate tax territory and subject to the current 40% federal estate tax rates.

Second, and more importantly for those same people currently above the estate tax threshold, the window is shrinking before the provisions of the 2017 TCJA expire on January 1, 2026. For them, the urgency to remove the assets from their estate before the interim reduction is magnified.

For private equity investors paying deferred interest, taking advantage of the current exemption thresholds may prove beneficial in the future.

For private equity investors paying deferred interest, taking advantage of the current exemption thresholds may prove beneficial in the future.

TCJA’s Impact on Private Equity

Enacted in 2017, the TCJA increased the exemption thresholds for estate and gift taxes. The current federal estate exemption in 2022 is $12,060,000 per person, or $24,120,000 shared between a married couple. Depending on the state in which you reside, you may also be subject to state estate tax. In Illinois, for example, the current estate exemption is $4 million per person and, unlike the federal limit, is not lumped in with your spouse’s $4 million.

With expectations that federal estate limits could be reduced to $5 million per person (indexed to inflation) in 2026 after the TCJA expires, highly prosperous families could lose the ability to give nearly 14 million dollars estate tax free over the next three years.

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But there are also implications for private equity investors earning deferred interest.

This form of compensation aims to align the compensation of general partners with the overall performance of the fund, amounting to a share of the overall profits of the fund. Basically, deferred interest is considered a return on investment, not traditional income. As a result, it is generally taxed at a lower rate as a capital gain.

While most private equity professionals typically focus on managing income taxes, those who are paid carry and who will potentially face estate tax issues should consider donating. These individuals have the unique ability to donate their carried interest to an irrevocable trust in the early stages of fundraising, while using an up-to-date valuation. If they are able to move their interest early on, the benefit is now captured in a vehicle that is no longer subject to federal and state estate taxes. This strategy can be executed at any time, but it is most powerful in the genesis of a fund.

Important Considerations

If you are a private equity professional, business owner, or someone who works with business owners in the negotiation space, this strategy should be at the forefront of your property tax reduction plan at long term.

What is the downside of giving these gifts? A common pain point is the fear of losing control of the assets that are given away, or potentially inadvertently giving away too much. Fortunately for private equity professionals, different strategies can be put in place to allow the growth of these assets to occur outside of their wealth, while still retaining some interest in themselves.

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It is also important to consider how and if these gifts will affect your future goals. The math can tell us there’s taxpayer money to be saved, but at what cost to your lifestyle and future cash flow? All of these variables should be strongly considered when consulting with your team of professionals, including your estate planning attorney and wealth manager. Everyone can explain the implications of different donation strategies, while understanding how they can affect the bigger picture in the long run.

Ultimately, if you fall into the category of taxpayers subject to estate tax now or in the future, now is the time to think about expediting donations to take advantage of current estate exemption amounts. .

Disclosure: Investments involve risk and past performance may not be indicative of future results. Balasa Dinverno Foltz LLC (BDF) investment strategy and wealth management recommendations may not be profitable, appropriate or equal to historical performance. BDF does not provide legal, tax, insurance, social security or accounting advice. The information in this document is provided solely for educational purposes on a variety of topics, including wealth planning, tax considerations, insurance, estate, gifts and philanthropic planning. BDF’s current written disclosure statement addressing advisory services and fees is available for review at www.BDFLLC.com or on request.

Sean Knoerzer CFP® joined BDF in 2014 and is an asset manager within the firm. As a member of BDF’s Finance Professionals Practice Group, Sean specializes in working with private equity professionals, offering solutions to their unique financial situation and providing insight into complex financial planning needs. Sean is a Certified Financial Planner™ professional. Sean gained experience in financial planning and marketing at Busey Wealth Management, Prudential Financial Services and Lionheart Financial Wealth Management before joining BDF in 2014. Sean graduated with a Bachelor of Science in Agriculture and Consumer Economics with a concentration in financial planning from the University of Illinois. While in Illinois, Sean was co-captain of the Illinois men’s rugby team. For more information contact Sean at [email protected]

Matt Kocanda CFP® leads BDF’s Finance Professionals practice group. In this role, he leads the strategy to meet the wealth management needs of private equity professionals, investment bankers and asset managers. Matt is also a member of the firm’s leadership team and serves as Director of Client Experience and Growth. In this role, he helps drive the day-to-day and strategic vision of customer experience and growth at BDF. He is enthusiastic about creating a great customer experience that helps BDF customers live their lives to the fullest. Prior to joining BDF, he spent six years in the Private Wealth Management division of Goldman Sachs. Matt earned his undergraduate degree in finance from Indiana University Kelley School of Business. Matt is a Certified Financial Planner™ professional. To learn more, contact Matt at [email protected]

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