At the beginning of July, it was reported that Donovan Mitchell, an NBA guard, agreed to a three-year, $150.3 million extension with the Cleveland Cavaliers. Entertainer Taylor Swift reportedly was paid $92 million in 2022. Jamie Dimon, the CEO of JPMorgan Chase, reportedly was compensated $36 million in 2023, including a base salary of $1.5 million and $34.5 million in performance-based compensation.
You are probably reading this and thinking to yourself, “I am not an athlete, entertainer, or CEO... what does this have to do with me?” Some of us may someday run into the same issues that these high-income earners encounter:
- Utilizing estate, gift, and generation-skipping transfer tax exemptions before current law sunsets;
- A major liquidity event in one year (examples: performance bonuses, winning a lottery, sale of a business, lawsuit payment);
- State income taxation on earnings based on state of residence (for example, all of the aforementioned occurring while one is a resident of California or New York); and
- An estate plan with no beneficiaries or heirs.
What can you do? Here are some common solutions for planning related to estate, gift, and generation-skipping transfer tax, major liquidity events, state income taxation, and estate planning for single individuals.
Using Exemptions Before They Sunset or Go Away
In 2024, the estate and gift tax exemptions are $13.61
million per person. The generation-skipping transfer tax exemption
is $13.61 million. On Jan. 1, 2026, these exemptions are scheduled
to sunset to $5 million, although that amount will be indexed for
inflation. Congress and the next President will have to address the
realities of our current economy and may let these exemptions
sunset.
Like Mitchell, Swift, and Dimon, individuals concerned about future estate tax liability should consider making a completed gift of their full exemption amounts, $13.61 million, as soon as possible. One strategy is to use a gifting vehicle, such as a dynasty trust. For example, Swift could name “future descendants” as the ultimate beneficiaries of the trust, and name charities, siblings, or parents as contingent beneficiaries should she have no children. For married individuals such as Dimon, estate planning techniques like Spousal Lifetime Access Trusts (SLATs) and Inter Vivos QTIP Trusts should be considered. By using SLATs and Inter Vivos QTIP Trusts, married individuals can retain indirect access to gifted assets while utilizing their exemptions.
In the case of someone like Swift, $13.61 million is only a small fraction of her net worth. The high-income earner has to start somewhere. But what does one do with the rest of it? For an athlete, entertainer, or executive who is a target of frequent litigation, an “incomplete gift plan" in the form of a self-settled domestic asset protection trust for assets above $13.61 million could be considered. In the near term, that type of trust can help preserve wealth. In the future, if the estate and gift tax exemptions increase, the high-income earner can make use of those increases through additional completed gifts by moving assets from his or her self-settled trust to the dynasty-like trust described above. If the exemption goes down, the “incomplete gift” self-settled trust (along with any previously completed gifts) remains intact. The use of “grantor trusts” indirectly allows a high-income earner to pay income tax owed on gifted assets resulting in additional “tax-free” gifts to a dynastic trust during his or her lifetime (or as long as “grantor trust” status is maintained).
Subject to the insurability of the high-income earner, he or she might also consider the use of Irrevocable Life Insurance Trusts (ILITs) to create liquidity with life insurance that can be used to pay for an estate tax liability. This can be useful if an estate contains a significant amount of illiquid assets, such as intellectual property, real estate or closely held businesses.
Planning During a Year Containing a Major Liquidity
Event
Utilizing the estate and gift tax exemptions is not
sufficient when an individual is subject to a large liquidity event
in one or more years. For Mitchell, post-contract in 2024,
utilizing his $13.61 million exemption still leaves him with
additional money to shield from taxes. When asset protection is not
the only concern, other planning should be initiated.
A Charitable Lead Annuity Trust (CLAT) is a trust funded with a large one-time transfer. “Lead” payments are made to a qualifying charity for a predetermined number of years, at the end of which any remaining trust property is paid to named individuals. For someone like Swift who presently has no heirs, this type of planning may require further brainstorming or flexibility.
Instead, a high-income earner with no children could consider creating a private foundation. The high-income earner could seed the private foundation with a large gift in year one in order to shield some of his or her salary from taxation.
Further, a Flip Charitable Remainder Trust (Flip-CRUT) could be used. A Flip-CRUT can be funded with a large one-time transfer. Instead of a CLAT (described above) that makes present distributions to a qualified charity, the trust creator is the present beneficiary. Since the trust creator with significant present earnings will not need distributions, the “flip” feature allows the trust creator to delay distributions for a period of years or until a triggering event, such as retirement. Until the trust flips, the assets remain invested. Once flipped, the trust creator begins receiving distributions continuing for his or her lifetime. Once the trust creator dies, the remaining trust assets are distributed to the qualified charity. Although the trust creator receives distributions continuing into the future, he or she receives a charitable deduction in the year the Flip-CRUT is funded.
A high-income earner is receiving his or her liquidity from salary. For others, the major liquidity event might come in the form of a sale of a business or real estate. Older clients are counseled to hold any assets with low basis until death so that heirs can inherit those assets with a stepped-up income tax basis. Assets with the potential for future growth could be gifted to Grantor Retained Annuity Trusts (GRATs). GRATs are similar to Flip-CRUTs in that the trust creator can retain the right to receive distributions for a term of years, with the remainder passing to named beneficiaries at the end of the term. The trust creator of a GRAT plans with the hope that if the asset appreciates in the future, the GRAT will shift the growth in value to his or her designated beneficiaries in continuing trusts.
Domicile and State Income Tax Planning
Just because Mitchell, Swift, and Dimon earn the majority
of their money in a high-income tax state does not mean that he or
she is domiciled there for state income tax purposes. For example,
many athletes, entertainers, and executives are domiciled in
Florida or Texas because those states have no state income tax.
Think of an executive who, during the pandemic, worked from his or
her Florida home or traveled back and forth between Cleveland and
Naples three working days a week.
Tax considerations aside, some states offer generous asset protection benefits. For example, individuals domiciling in Florida can receive creditor protection for their retirement plans, annuities, and the cash value of life insurance. They can also benefit from an unlimited homestead exemption. In contrast, other states do not have similar exemptions.
Many states without generous creditor exemptions historically have higher income taxes, property taxes, and cost of living. Individuals in low-exemption high-income tax states should consider other asset protection vehicles. In addition to the self-settled domestic asset protection trust previously discussed, one could also consider umbrella insurance policies for added creditor protection. However, umbrella insurance policies can be costly for high-earners, and like any insurance product, there is a reluctance on the part of the insurance company to pay out during a major loss.
Domicile can impact marital rights. Whether someone is domiciled in a community property or non-community property state will determine how assets are treated during their lifetime and divided in the event of a divorce. Prior to marriage, high-income earners should consider establishing a prenuptial or premarital agreement to clearly define the expectations of both parties and protect assets acquired prior to marriage in the event of divorce.
When a high-income earner works and resides in different states, he or she needs to pay particular attention to the amount of time spent in any one state. There is no single rule establishing domicile. Instead, the high-income earner will be judged on a collection of facts and circumstances. Some factors considered include the state a driver's license is issued, vehicle registration, voter registration, mailing address, property ownership, club memberships, professional contacts, location of liquid assets (community bank or national brokerage firm), and the number of days physically in a state.
Estate Planning for Single Individuals and Individuals
with No Beneficiaries
Single individuals with no children or grandchildren, like
Swift, are not easily able to spend down their estates utilizing
annual exclusion gifting or paying directly for education or
medical expenses. When a person has no ascertainable beneficiaries,
he or she should consider charities, friends, and other
non-immediate family members as potential beneficiaries. As an
example, Swift has a younger brother (Austin Swift) and a
significant other (Travis Kelce) for whom she could pay medical
expenses directly (hospital and physician bills) to further spend
down assets (albeit her brother and significant other have money of
their own). For other high-income earners, paying tuition or
medical expenses directly for nieces, nephews, and other close
relatives, or establishing a foundation or donating to other
charitable organizations, provides a significant benefit when the
choice is between taxes and helping others.
For high-income earners, deciding who should be the healthcare decision maker and financial power of attorney poses unique challenges when there are potential bad actors in such a person's life. Having a team of advisors and trusted persons who regularly communicate is an ideal solution to the decision-maker conundrum.
High-income earners are targeted by unscrupulous insurance and financial advisors. For example, high-income earners are often pitched large disability policies and term life insurance policies with high face values. These lead to higher commissions for advisors but may not lead to an ideal solution. Although younger high-income earners may never be easier to insure, and the insurance may never be cheaper, other investment opportunities could be better planning tools. Vetting advisors and receiving second and third opinions leads to better planning outcomes.
Conclusion
At various points in our lives, we may encounter financial
challenges similar to those faced by Mitchell, Swift, and Dimon.
Some may need to navigate estate, gift, and generation-skipping
transfer taxes or manage major liquidity events, while others
grapple with state income tax issues and estate planning concerns
as singles or individuals without heirs. In these situations, a
qualified team of advisors who offer tailored solutions, rather
than sell products, will direct the high-income earner towards the
best results.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.