- Cash-poor but asset-rich families can use loans to pay estate taxes rather than sell inherited assets.
- For those with illiquid estates, they can even deduct the interest and save millions on estate tax.
- Four lawyers tell Insider how loans can help families preserve wealth and pay less to Uncle Sam.
Nothing is certain but death and taxes. But for America’s wealthy, there are ways to modify how much you pay in estate tax and when — if you have a savvy financial advisor.
Currently, a 40% federal estate tax applies to estate values topping $12.06 million for single individuals and $24.1 million for married couples. When someone dies, their heirs have nine months to file a federal estate tax return if their inheritance meets those minimums.
Some of the uber-rich are asset-rich but cash-poor with their fortunes tied up in illiquid assets such as real estate or privately-held businesses. They can rush to sell those assets to make the nine-month deadline, or take a loan, whether it’s from a bank or a trust, in order to pay Uncle Sam.
“You obviously have to pay the estate tax, but in the meantime, you’re not forced into a fire sale of potentially-income producing assets, and you can use the income from those assets to pay off the interest of the loan,” explained Jere Doyle, senior vice president and estate planning strategist at BNY Mellon Wealth Management.
Furthermore, if illiquid assets make up at least 35% of the estate’s value, families can defer estate tax for as much as 14 years, paying in installations with interest, and effectively taking a loan from the government.
Insider talked to four lawyers to learn how the rich can use loans to hold onto family businesses and other illiquid assets and even save millions on estate taxes.
Loans are worthwhile to save assets likely to appreciate, but there’s a lot of hoops to jump through
Most banks are loathe to extend loans to estates. “No one wants to stand in line with estate creditors,” said Jose Reynoso, senior managing director of Clarfeld Citizens Private Wealth.
But taking a loan from a related party is often in the family’s best interest. If the loan is given by a related party such as a family limited partnership or a trust funded by the decadent’s life insurance, the estate is essentially paying itself back for the loan.
“It’s a win-win-win,” Doyle said.
To get another win, estates can take out a Graegin loan in order to pay estate taxes and subtract the interest upfront from their estate tax burden. The technique is named after a 1988 Tax Court which ruled that interest payable on a loan to pay estate tax was deductible upfront. Graegin loans are only used for large estates so the interest savings are considerable.
Here’s how a Graegin loan could work in practice, according to Doyle:
Heirs of a $10 million estate could be on the hook for $4 million in federal estate taxes. If they use a Graegin loan with $1 million of interest, and the entire sum can be deducted upfront on the estate tax return. The taxable estate is $1 million less, which means the family will save $400,000 in estate taxes considering the 40% tax rate.
The family is still on the hook for the interest on the loan, and the net cost after the estate tax savings will be $600,000, but those installations are paid over the term of the loan. In the meanwhile, the family can hold onto appreciating assets and use their cash flow to pay off the loan.
However, Graegin loans come with lots of strings attached. The debt has to be shown to be bona fide – that there is real expectation of repayment and an intent to enforce the collection of debts. The estate also has to demonstrate the loan is necessary to pay the tax and administrative expenses in order to avoid a forced sale.
Graegin loans are uncommon and subject to scrutiny by the IRS
Graegin loans are rare and typically a last resort, according to Eric Mann, a partner at Neal Gerber Eisenberg. For instance, loans can become necessary if the client worked with an “aggressive” investment manager that overallocated to highly illiquid assets like private equity.
“Graegin loans come up when you have a situation where someone has passed away, someone who did not do enough planning and encircled themselves with improper professionals, and now they have a
problem,” said Mann, who typically works for clients worth at least $100 million.
Graegin loans are prime targets for auditors, lawyers warn, which is part of why they avoid them. The IRS does take some families to court.
For instance, the estate of John F. Koons, III, a Pepsi distributor, claimed a $71.4 million deduction on a $10.75 million loan from an LLC controlled by the heirs. After a years-long legal battle decided in 2017, the court ruled that the loan was not necessary as the heirs could have used funds from the LLC to pay the taxes. After interest, the estate owed $42.78 million more in the estate tax to the IRS.
Loans to pay off estate taxes could become more popular after the estate tax exemption halves in 2026
Thanks to tax law passed in 2017 by Republicans that doubled the asset threshold for federal gift and estate tax, very few Americans have to worry about estate taxes. According to the latest data available from the IRS, only 3,441 estate tax returns were filed in 2020 and only 1,275 were taxable.
With valuation discounts, a married couple could conceivably pass on $36 million in assets without paying federal estate tax, according to Robert Strauss, partner at Weinstock Manion.
“This is a wealthy person’s playground problem,” Strauss told Insider.
But the upper tax threshold is due to sunset in 2026 to $5 million, adjusted for inflation from 2018. More households will be on the hook for estate taxes, and loans to pay them could become more popular.
“Maybe small businesses will be impacted, less sophisticated business owners who haven’t sought as much outside planning advice and haven’t had a chance to accumulate liquidity outside of what the business generates,” said Reynoso.
But it’s hard to predict if the sunset will actually happen. Strauss thinks that by 2026, the presidency and Congress will be controlled by the Republican party, which would be inclined to extend the exemption.