Client's Guide to Estate Tax Planning
"In this world, nothing can be
said to be certain, except death and taxes."
Benjamin Franklin (1706-1790)
You may have an unwanted beneficiary in your
estate plan. It's your Uncle Sam, and the IRS wants to make sure
that he gets his share.
Uncle Sam's share of your estate is called the
federal estate tax, and depending on the value of your estate and the
year of your death, his share can be as much as 55% of your estate -
that's right, more than half!
In computing the value of your estate in order to
determine the tax, all of your assets are totaled up at their fair
market value, typically as of your date of death. It includes the
value of your home and other real estate, bank accounts, CD's, stocks,
bonds and other financial investments, business, retirement and pension
plans, cars, boats, furniture, jewelry and other collectibles, patents,
trademarks and anything else of value. It also includes,
surprisingly to most, the proceeds of any life insurance that you own on
your life. The total amount is called your "gross estate."
If you own property jointly with a spouse, then
one-half of the value of the property is included in your gross
estate. If you own property as joint tenants with right of
survivorship with anyone other than your spouse, then all of the
property value is included except to the extent it can be proved that
the other co-owner provided the funds to purchase the property.
After totaling up your gross estate, the following
deductions are made in order to arrive at your "taxable estate":
(1) debts that you owe at death, (2) administrative expenses (executor
commissions, legal and accounting fees) incurred in administering your
estate, (3) funeral expenses, (4) amounts left to charity (the
"charitable deduction"), and (5) amounts left outright to your
spouse or in a qualifying trust for your spouse's benefit (the
"marital deduction"). Because of the marital deduction,
estate taxes are generally not payable in the case of married couples
until the death of the surviving spouse.
A tentative tax is then computed on the value of
the taxable estate, and the tentative tax is then reduced for any
credits to arrive at the final estate tax. The most important
credit is the "unified credit" (now also called the
"applicable credit amount"), which in 2015 will be sufficiently
large to exempt a taxable estate of up to $5,430,000 from federal estate
tax. This exemption amount is called the
"applicable exclusion amount."
Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), as amended by the Taxpayer Relief Act (TRA) of 2012,
that here), the
credit amounts and tax rates have been made permanent. The good news is that clients can finally plan knowing what the tax laws should be on their deaths. The bad news is that outright estate tax repeal is no longer on the horizon.
continue to believe that every single person and married couple whose expected gross
estate exceeds $5,000,000 (which again, includes the proceeds of any
life insurance) should be concerned about estate taxes and should plan
Here are some techniques that you can use to cut
Uncle Sam out of your
Step 1: Make maximum use of
your "applicable exclusion amount." With married couples, some planning is needed to
ensure that the applicable exclusion amount of the first spouse to
die is not wasted, which will happen if all assets are left outright to
the surviving spouse. Typically this planning is accomplished by
having a sufficient amount of assets on the death of the first spouse to
die held in a Family Trust (also known as a "Bypass Trust," a
"Credit Shelter Trust" or a "B" Trust) of which the
surviving spouse may serve as Trustee and from which the surviving
spouse can receive distributions as necessary without having the trust
assets be subject to estate taxes on the surviving spouse's death.
The Family Trust is generally set up under a Living Trust.
Assets not used to fund the Family Trust may
be left outright to your spouse or in a Marital Trust that qualifies for
the estate tax marital deduction (also known as a "QTIP Trust"
or an "A Trust"), under which the spouse will receive all of
the trust income and can receive other distributions as necessary.
Marital Trusts are very popular in second marriage
situations where one spouse wants to ensure that the other is provided
for during his or her lifetime, but wants to ensure that the
surviving spouse cannot disinherit the children from the prior
Marital Trusts are also useful if professional
asset management is desired and to protect assets from any creditors of
the surviving spouse.
Note: TRA 2010, made permanent under TRA 2012, for the first time allows for the portability of a predeceasing spouse's unused estate tax exemption to the surviving spouse, with the result that the surviving spouse's estate tax exemption on his or her subsequent death will be whatever exemption applies at that time plus the predeceasing spouse's unused estate tax exemption. Because there are restrictions and pitfalls to portability, we do not recommend married clients relying solely upon it in their planning at this point.
Step 2: Remove the proceeds of
your life insurance from your taxable estate by using an Irrevocable
Life Insurance Trust.
The proceeds of any life insurance policy on your
life that you own at death will be subject to federal estate taxes under
Internal Revenue Code 2042. This means that a person with a net worth less than the $5,430,000 estate tax exemption has to worry about estate taxes if he or she
owns substantial life insurance.
By establishing an Irrevocable Life Insurance
Trust and making the Trust both the owner and the beneficiary of the
policy, these taxes can be avoided. There is a rule under which
the proceeds will be subject to estate tax if you transfer an existing
policy to a trust and die within three years of the transfer. This
three-year rule does not apply if the trust is the original owner and
beneficiary of the new policy. Also, this three-year rule may be
avoided in some cases even with respect to transfers of existing
policies using sophisticated techniques.
If you are married and if your spouse is the
beneficiary of your life insurance, the proceeds will not be subject to
estate taxes upon your death (assuming your spouse survives you).
However, any portion of the proceeds that your spouse does not spend or
give away will be potentially subject to estate taxes upon his or her
later death. Proper use of an Irrevocable Life Insurance Trust
prevents this, and will also protect the proceeds from your spouse's
For a more detailed discussion of the use of
Irrevocable Life Insurance Trusts, please read our Client's
Guide to Irrevocable Life Insurance Trusts.
Step 3: Reduce your taxable
estate by making annual gifts. You can give up to $14,000 each
year to each of your children, grandchildren, or anyone else for that
matter without reducing your applicable exclusion amount or incurring a
gift tax. The number of potential recipients is limitless.
Many clients who want to make sure that their
gifts are not frivolously spent by or subject to creditors of the gift
recipients establish an Irrevocable Gift Trust.
To read more about Irrevocable Gift Trusts and
other gift mechanisms, please read our Client's
Guide to Gifts and Gift Trusts.
Step 4: If Steps 1 through 3 aren't enough, then further estate tax savings can be achieved through
sophisticated estate planning techniques including Qualified Personal
Residence Trusts (QPRT's), Grantor Retained Annuity Trusts (GRAT's),
Installment Sales to Irrevocable Gift Trusts, Private Annuities,
Self-Canceling Installment Notes, and other measures.
Clients desiring to benefit charities as well as
reduce estate taxes by means of the charitable deduction should consider charitable planning options,
including private foundations, charitable remainder trusts, and
charitable lead trusts, which are further discussed here.
Planning Your Children's Estates:
Foresighted clients who want to maximize their children's inheritances
provide that upon the death of the surviving spouse, the maximum amount
permitted under the tax law passes to a Dynasty Trust that will never
be subject to federal estate taxes during its existence and can benefit
children, grandchildren, great-grandchildren and so on for up to 360
years! The maximum amount that can be used to fund a Dynasty Trust
in 2015 is $5,430,000 ($10,860,000 for married couples with proper
Dynasty Trusts are sometimes misleadingly called
"Generation-Skipping Trusts" but the only thing skipped are
the estate taxes, not the benefits of the inheritance! Your
children can receive distributions from the Dynasty Trust, can serve as
Trustee at such age and upon such conditions as you direct, and can have
the ability to specify how the trust assets will be divided in the event
of their deaths among their own children.
Dynasty Trusts not only avoid future possible
estate taxes, but along with other trusts you can set up for your
children, provide other valuable
benefits as well.
Conclusion: Congress may not have succeeded in
the estate tax, but with proper planning, maybe you can!