Right out of the gate, Turney P. Berry’s Heckerling lecture entitled “Not Too Rich, Not Too Poor: Goldilocks Planning for the middle-rich Clients Who Need Our Help” makes clear that planning for the “middle-rich” is planning for individuals who have wealth that vastly exceeds the unified credit amount (currently $12.92 million). In his estimation, being mddle-rich starts with having $20 million in assets and a 20-year life expectancy. Someone who has a longer life expectancy would need more assets to be considered middle-rich, and a middle-rich couple would have around $40 million in combined assets.
Individuals with this level of wealth can’t rely on exemption or portability planning and are looking for other techniques to minimize estate taxes, but generally, they aren’t interested in taking large risks on controversial, cutting-edge and untested estate tax reduction techniques (which may be attractive to the ultra-wealthy). During his hour at the podium, Berry succinctly laid out the important steps in which the middle-rich individuals should be engaging to minimize their estate tax liability. First, maximize annual gifting (one assumes that this also includes making as many Internal Revenue Code Section 2503(e) medical and educational gifts as possible). Second, use lifetime exemption by gifting assets to trusts (this is where many middle-rich clients get nervous because it involves them divesting themselves of assets during their lifetime). Lastly, use grantor-retained annuity trusts to remove assets from the estate when there’s no exemption left to use.
In his discussion, Berry identified the stumbling blocks for many members of the middle-rich when discussing and engaging in lifetime gifting: lack of control over the gifted assets and lack of access to income. To ease these clients into giving up control, he suggested establishing trusts in which the middle-rich settlor initially maintains control over the assets and then ease them out of a position of control over a period of time (which must occur more than three years before the settlor’s death to ensure that the assets are out of the settlor’s estate). Alternatively, the settlor could be an investment advisor to the trustee (where the trustee isn’t bound to follow the recommendations of the investment advisor). To allow the clients to access income from the gifted assets, Berry recommended the following techniques: (1) gifting the assets to a grantor trust with a power of substitution and as the gifted assets generate income, substitute outside assets for the liquid income being generated inside of the trust, (2) selling assets to a grantor trust in return for a promissory note in which the income generated by the assets is used to pay off the note, or (3) gift the assets to a spousal lifetime assets trust, in which the settlor’s spouse has an income interest (which can indirectly benefit the settlor).
All of these aforementioned techniques will require a valuation of the asset being gifted or sold to the trust. Berry’s experience with the middle-rich tells us that they don’t want to litigate valuation issues and instead want certainty in the value of their gifts, so that they don’t exceed the lifetime exemption (whereas the ultra-wealthy might be more willing to litigate these issues with the end goal of moving more assets - such as a larger percentage interest in a company - out of their estate). So, how do we, as advisors, provide them with as much certainty as possible? First and foremost, any time a client gifts or sells an asset to a grantor trust, said asset needs to be valued by a qualified professional. Secondly, if a client is making a gift of a difficult to value asset, they should make a formula gift of the asset so that the gift isn’t larger than the settlor’s unused exemption. It’s important to note, however, that the Internal Revenue Service doesn’t like this type of fractional gift. Lastly, if the settlor is charitably minded, the settlor could gift the asset to a trust and direct the trustee to allocate any portion of the gift that exceeds the lifetime exemption to charity or donor-advised fund. If a client wants to engage in this type of planning, it’s important to obtain substantiation from the charity. Berry contended that the IRS is unlikely to contest this type of gift if all substantiation and valuation documentation is included with the gift tax return.
Another planning technique that advisors might address with middle-rich clients is “upstream planning,” which allows assets that have been gifted to a trust to obtain a basis step-up. To use this technique, the client establishes a trust for the benefit of their descendants, but in the trust gives a parent a circumscribed general power of appointment (CGPOA) over a portion of the property equal to the parent’s remaining exemption so that at their death, the assets over which the parent has the power of appointment will be included in the parent’s estate and will get a step-up in basis. The CGPOA should only be exercisable in favor of the creditors of the parent’s estate with the consent of a non-adverse party and may only be exercised over assets that have a higher fair market value than basis. This can be a little tricky as some states have state estate tax, so it’s important to look at the parent’s estate and federal estate tax liability, as well as whether their estate is highly susceptible to creditor claims before implementing upstream planning.
Sometimes, clients are just too nervous to engage in these techniques, especially when the financial markets are volatile. If you come across such a client, Berry recommended easing the client into estate planning by doing their ancillary documents first and working up to gifting.
On a final note, it’s important to remember that the exemption is set to decrease to $5 million, indexed for inflation, in 2026. At that time, the estate planning community’s definition of middle-rich will need to change as many more people will be subject to the federal estate tax.
Molly Soiffer is an attorney focused on estate planning at Bove & Langa in Boston