Actor Will Rogers once said, “Now they got such a high inheritance tax on ’em that you won’t catch these old rich boys dying promiscuously like they [once] did. This bill makes patriots out of everybody. You sure do die for your country if you die from now on.” While this was first quoted nearly a century ago, it’s a sentiment that still resonates with Americans several generations later.
People who have been taxed on their wealth throughout their life are typically less-than-enthused by the prospect of their estate facing additional taxation when it is disbursed to heirs. That’s why many high net worth individuals were relieved when new estate tax laws were passed for 2018 that significantly increased the federal estate tax exemption amount.
As an executive financial advisor, I can tell you that these changes don’t make estate planning irrelevant, especially if you own executive stock options. These stock options can potentially create a large tax burden, regardless of the current estate tax laws.
If you are an executive with company stock options, here’s a closer look at how the new estate tax laws in 2018 can affect you. We’ll also discuss why you should consider removing your stock options from your estate and a strategy for doing that.
What Do the Estate Tax Laws in 2018-2019 Mean for You?
To understand how you might be affected by the new estate tax laws in 2018, let’s start with what the laws actually are.
The inflation-adjusted estate tax exemption amount is currently $11.18 million. According to the IRS, estate taxes must be filed for estates with combined gross assets and prior taxable gifts above this amount. The new estate tax laws nearly double the exemption amount from 2017, which was $5.6 million. As it now stands, any inheritance received above the exempt $11.18 million is taxed at a 40% tax rate.
Regardless of these new laws, however, it is still important to work with your wealth manager, in conjunction with an estate planning attorney, to develop an estate planning strategy. First of all, the current exemption amounts are temporary. In 2026, they will revert back to the 2017 limits, and that is if no other administration decides to change the laws before then.
Secondly, as a top-level executive, you likely have a large portion of your overall net worth tied up in employee stock options. These stock options can be especially tricky to handle because when they are granted, the price that you pay for the stock when you exercise your option is much lower than what they will be worth in the future. This can cause a large potential tax burden on your estate.
Removing Stock Options from Your Estate
You will want to consider removing stock options from your estate if your net assets are above the $11.18 million taxable threshold. For top-level executives, this can be an effective way to lower the overall size of your estate to avoid further taxation for your family.
One way to remove stock options from your estate is to gift those options. If you have worked for the same company for many years, there’s a good chance that the company stock has grown to a much higher value than when your options were granted to you. You will pay some taxes on those options one way or another, no one has ever found a legal way out of that. However, gifting those stock options and paying some tax on them now could potentially save you much more down the road.
Here’s how this strategy works:
By gifting your stock options, you give the recipient the ability to exercise the option whenever they choose. If you gift $30,000 or less to a married couple, it falls under the tax-free gift amount. Anything gifted over that amount would go toward the $11.18 million lifetime gift tax exclusion per the new estate tax laws in 2018. You will be held responsible for paying taxes on the compensation element (the difference between the exercise price and the current market value). With non-qualified stock options, this amount will be taxed as ordinary income when the recipient exercises your gifted options.
While you will incur some taxation, you will be completely eliminating those options from your estate and therefore effectively lowering your overall estate amount. This helps prevent your family from having to pay the 40% (or more if laws change in the future) in estate taxes on the total above the estate tax exemption amount.
In the end, political administrations will change, tax codes will fluctuate, and different years will bring different rules. Working with an experienced executive financial advisor can help ensure your estate plan is up to date. This is especially important for top-level executives who carry a large amount of their net worth in company stock options. Understanding how and when to remove stock options from your estate can be crucial to keeping your estate under those federal estate tax exemption limits. Will Rogers may be right, but if you do your homework and work with experienced professionals, you can avoid passing on a tax burden to your loved ones.
K. Wade Carpenter, CFP®, AIF®, ChFC®, CLU®, is an innovative wealth manager serving corporate executives and entrepreneurs from coast to coast. Throughout his more than 25-year career, Wade’s focus on C-level clients has made him a top strategist for integrated asset allocation and equity compensation management. He has developed estate planning strategies for corporate executives with equity compensation plans. For more information on how Wade and the Carpenter Team can advise you on the estate tax laws in 2018-2019, reach out today for a complimentary consultation.
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