Use It or Lose It: Why PE Partners May Want to Use Tax Exemptions Now

Many private equity partners realize it’s no longer a question of if, but rather a question of when taxes will go up. The answer could be sooner rather than later.

Currently, the federal estate and gift tax exemption amount is $11.58 million per individual, or $23.16 million for married couples. There is an equal generation-skipping transfer (GST) tax exemption amount of $11.58 million per individual to shelter gifts to individuals who are more than one generation younger than the donor. Those exemption amounts are set to increase annually through 2025. On January 1, 2026, absent a change in law, the exemptions will revert to $5 million indexed for inflation from 2018 (resulting in an exemption of $5.6 million+).

However, those exemption amounts could come down much sooner than planned … potentially as soon as next year. Certainly, the outcome of the election could alter the tax landscape. For example, Joe Biden has proposed reducing the gift and estate tax exemption amount by 50 percent, and eliminating the step-up in basis rules that currently apply to inherited assets.

Add to that the trillions of dollars in government stimulus spending in response to the pandemic that will need to be paid for. That likely means higher tax rates and other changes to tax law.

For private equity partners, the time is now to take a hard look at estate planning and gifting strategies, as we may soon be in a “use-it-or-lose-it” scenario.

What to Give

All things being equal, it is best to gift assets with the greatest appreciation potential, as all future appreciation escapes estate tax. That being said, it is important not to gift assets you will need to fund your lifestyle. Identify those assets that won’t be missed, and back into the appropriate assets to give from there.

For many fund principals, this often means transferring a portion of their carried interest.  Importantly, there are technical limitations that need to be followed to avoid a deemed gift of the entire fund interest. More specifically, when transferring carried interest, you must transfer a proportionate amount of all your equity interests in the fund (i.e. a “vertical slice”). The closer the transfer is done to the inception of the fund, the greater the efficiency of the transfer.

How to Give

Gifts can be made outright or to a trust for the benefit of descendants or a spouse through the use of a Spousal Lifetime Access Trust (SLAT). Simply put, a SLAT is an irrevocable trust formed by one spouse (the grantor spouse) for the benefit of the other (the beneficiary spouse). When properly crafted, the SLAT removes the transferred property from the estates of both spouses, while still giving the beneficiary spouse limited access to the assets if they are needed. If a family already has irrevocable trusts in place, it may be possible to gift additional assets to those trusts to reduce the time and expense involved in making a transfer.

How Much to Give

As stated above, the estate and gift tax exemption amount could become a “use-it-or-lose-it” scenario sooner than otherwise anticipated. If the exemption amount is reduced, any gifts made in the past will count against the new lower exemption amount.

Therefore, if a married couple can afford to use both spouses’ remaining gift tax exemptions (a total of $23.16 million, less any exemption allocated to previous transfers,) they should. If the couple can’t, or is not comfortable using both exemptions, one spouse can use his/her exemption in full, with the other giving what he/she can, rather than making gifts in equal amounts. Keep in mind that even if a trust is structured so that a spouse is a beneficiary, the funds in the trust should be the last assets used, as the goal is to deplete the taxable estate before spending down protected assets.

In summary, changes to tax laws are likely looming. Private equity partners should work with qualified advisors in anticipation of higher tax rates and lower exemption amounts to determine how much and how best to gift.

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About Cresset

Cresset is an independent, award-winning multi-family office and private investment firm with more than $50 billion in assets under management (as of 06/06/2024). Cresset serves the unique needs of entrepreneurs, CEO founders, wealth creators, executives, and partners, as well as high-net-worth and multi-generational families. Our goal is to deliver a new paradigm for wealth management, giving you time to pursue what matters to you most.

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