Estate Tax & Wealth Transfer
If you don't plan properly, the government could confiscate significant portions of your assets through estate taxes. Shouldn't your money go to your family and chosen beneficiaries, not the IRS?
No matter how overtaxed you think you are during life, the government will want to review your estate at death to ensure you don't owe that one final tax: the Federal Estate Tax. In addition, New York has its own separate estate tax regime that must be dealt with. Whether there will be any tax to pay depends on the size of your estate and how your estate plan works.
ESTATE TAXES 2010, 2011, 2012
The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 signed into law on December 16, 2010 made significant changes to the Federal Estate, Gift and Generation Skipping Transfer Tax laws. The primary changes included raising the exclusion amounts for all three taxes to $5 million per person and reducing the tax rate to 35%.
It is important to realize that this law will expire in 2013 without further Congressional action and the law will revert to the "old" rates ($1 million per person and a top rate of 55%+). It is strongly recommended that clients do not make plans (or fail to plan at all) on the assumption that the current provisions will remain in effect long term and these transfer taxes won't apply to them. Failing to plan properly is inviting disaster given the uncertainties of the future and the unstable political and financial situation in the country.
The new tax law provides many great benefits and planning opportunites, but only a qualified estate planning attorney can guide you through the details. Contact us now to set up a free consultation to discuss your personal situation.
There are many well-established strategies that can be implemented to reduce or eliminate death taxes, but you must start planning process early in order to implement these plans.
Credit Shelter Trust
A person may leave a specified amount of assets ($5.12 million in 2012) to any beneficiary without incurring federal estate taxes (although any amount over $1 million will incur New York State Estate Tax). In addition, he or she may leave any amount to his or her spouse free of estate taxes. Since most folks want to leave most or all of their estate to their spouse, this is a great planning tool.
The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 allows a surviving spouse to carryover the unused exclusion amount from their deceased partner and add it to their own estate at death. This means at couple can shelter up to $10 million of assets even if they leave everything to each other outright. Prior to this new law, accomplishing this feat required the use of a Credit Shelter Trust.
Both a Will and Revocable Living Trust can be drafted to include a Credit Shelter Trust, which is designed to be funded with an amount of assets equal to the estate tax exclusion amount upon the death of the first spouse. The surviving spouse retains the right to draw funds from the trust as and when needed, and the remainder passes to the children or other beneficiaries free of estate tax. To make this work, it is important to have assets titled properly.
It is vital to understand two important issues:
1) The 2010 law will expire in 2013 without Congressional action. This could leave clients who have not added a Credit Shelter Trust to their plans exposed to a potentially huge tax bill.
2) Using a Credit Shelter Trust to hold the exclusion of the first spouse provides significant benefits, including: protecting the assets from lawsuits, creditors, remarriage/divorce, mismanagement, poor spending habits, etc. The assets held in a Credit Shelter will also grow without triggering additional transfer taxes. Assets left directly to a spouse are subject to all of these dangers.
Irrevocable Life Insurance Trust (ILIT)
Although life insurance proceeds are generally free from income tax, they do form part of the gross estate of the deceased owner, and are thus subject to estate tax.
An ILIT is an irrevocable trust used to avoid inclusion of life insurance payouts in the taxable estate of the decedent insured. If done properly, the insurance payout will not be subject to estate tax. The ILIT is generally structured so that it will provide benefits to the insured's surviving spouse without inclusion in the surviving spouse's gross estate.
An ILIT can be useful in providing liquidity to the insured's estate. Estates often consist of hard-to-sell assets such as real estate, business interests, and art work. The trustees of an ILIT can use the proceeds of the life insurance policy to buy those assets in order to allow the estate to have sufficient cash to pay estate taxes and outstanding debts.
Qualified Personal Residence Trust (QPRT)
A QPRT is an irrevocable trust to which the owner ("grantor") of a principal residence or second home may transfer that property, for the ultimate benefit of children, thereby removing the value of that property and any additional appreciation from the estate of the grantor in order to avoid burdensome estate taxes. Under a QPRT, the grantor retains the right to live in the property until a specified time, at which point ownership of the property will fall to the beneficiaries of the trust.
The QPRT can be an excellent way to save estate taxes. However, there are important gift and income tax issues that should be considered before implementation.
Gifting Programs
Parents and grandparents can significantly reduce their taxable estates through properly implemented gifting programs that involve transfer of assets to, or for the benefit of, children and grandchildren. These gifts can be made directly to beneficiaries, but many clients prefer to avoid doing so due to the age or personal situation of the intended recipient. Popular alternatives include gifts to 529 college savings plans (which can take advantage of special 5 year lump sum gift rules), transfers to specially designed "minor's trusts" (2503c trusts), or direct payment of the beneficiary's medical or tuition bills.
Grantor Retained Annuity Trust (GRAT)
The GRAT is a way of shifting wealth, practically free of transfer taxes, from the grantor of the trust to his beneficiaries. It is an advanced but fairly low risk strategy that works very well with assets that are expected to appreciate significantly (e.g. pre-IPO stock) or are heavily discounted (e.g. limited partnership interests). It can be especially effective in a low interest rate environment.
Sales to an Intentionally Defective Grantor Trust (IDGT)
The IDGT is an irrevocable trust that allows us to "freeze" the value of assets for estate planning purposes. The trust is structured so that the grantor is treated as the "owner" of the trust for income tax purposes but he or she does not retain an interest in the trust, ensuring all of the assets pass to children or grandchildren as beneficiaries.
To properly implement this strategy the grantor sells assets (e.g. stock, limited partnership interests, real estate, etc.) to the trust in exchange for an installment note with interest (at a rate set by IRS tables). The installment note is for a period of years. Upon the grantor's death, only the fair market value of the note is part his estate, which will be less than the outstanding principal of the note depending on several factors, including the payout of the note, the interest rate, default provisions, covenants, etc.
The IDGT technique freezes the value of the note in the grantor's estate. Any increase in value of the sold assets will not be taxed in the grantor's estate and will inure to the benefit of the trust beneficiaries.
Family Limited Partnership or Family Limited Liability Company (FLP or FLLC)
A Family Limited Partnership (or LLC) is a complex legal entity with its own tax identification number that provides many tax and legal benefits when properly structured. FLPs are often a key component of any advanced estate or asset protection plan and function best when combined with GRATs, DAPTs, gifting programs, and other planning techniques.
Dynasty Trusts
Some families with sufficient wealth may wish to employ trust provisions that provide for assets to be transferred to future generations through special generation skipping provisions. Assets can be held in a trust for the limited use and benefit of the children, and then retained for the benefit of grandchildren or great-grandchildren, all while avoiding generations of potential estate taxes. The tax code contains many traps for those unfamiliar with this type of planning, but when handled by attorneys with expertise in this area, such "Generation Skipping Transfers" can be powerful and effective tools of wealth transfer and family guidance.
Charitable Remainder Trust (CRT)
A CRT is an irrevocable trust that allows the grantor of the trust to receive an income stream from the trust assets for a period of years or the remainder of the grantor's life. Upon the grantor's passing, the residual funds in the trust ("remainder") pass to a charity of the grantor's choosing. Although the trust is irrevocable, the grantor may change the charitable remainder beneficiary at any time.
A CRT is considered separate from the grantor's estate and is therefore not subject to estate taxes. In addition, upon setting up this trust, the grantor receives a current charitable income tax deduction for the charitable remainder amount. Because charitable donations are not subject to capital gains tax, assets that are have significantly appreciated in value (like stock or real estate) are well suited to be placed in a CRT.
Charitable Lead Trust (CLT)
CLT works similarly to a CRT, except that the charitable organizations receive the payments throughout the term of the trust, while the owner's family receives the remainder of the assets in the trust upon expiration of the trust term. A CLT can be established either during your life or in your will.
Like the CRT, the CLT offers charitable tax deductions. However, because the ultimate asset is to pass to an heir, not a charity, the original transfer is subject to gift tax on the remainder value. The benefit of the CLT is that the IRS considers the gift to have been made on the day the asset is donated to the trust, not a number of years later, when it eventually passes to the beneficiary of the trust. If the asset has appreciated significantly in value over the trust term then the beneficiaries inherit a valuable asset free of estate tax, which would have been significantly higher than the gift tax originally paid by the donor.
Private Foundations
A private foundation a charitable organization created and funded by a single source, such as an individual, family, or corporation. It will typically make grants to other charitable organizations (e.g. Red Cross, American Cancer Society, etc.) rather than directly operating any charitable services or programs. A private foundation does not solicit funds from the public at large. The founder of a private foundation can elect himself or his/her family members as directors of the foundation thereby allowing the family to remain in control of the distribution of money or assets. In addition, they may draw reasonable compensation for services performed while running the foundation.
Since a private foundation is a charitable organization, it is exempt from federal income tax on its income, although it must pay a 1 to 2% excise tax on its net investment income. The gifts made to establish a new foundation or grow an existing foundation provide the donor with income, gift and estate tax deductions.
Estate planning is a complex field, and you should strongly consider working only with a qualified attorney whose practice is dedicated to this area. We are proud to say that is precisely who you will find at Donlon & Associates PC. Contact us now to set up a free consultation to discuss your personal situation.