Estate Tax & Wealth Transfer
If you don't plan properly, the government could confiscate nearly half of your assets through estate taxes. Shouldn't your money go to your family and chosen beneficiaries, not the IRS?
Effective January 1, 2010, the Federal Estate Tax and Generation Skipping Transfer Tax have been repealed for decedents dying during 2010. The Gift Tax remains in effect, with a 35% rate, a $13,000 annual exclusion, and a $1,000,000 lifetime exemption. The New York State Estate Tax also remains in effect.
In addition to these changes, the law now limits the so called "Stepped Up Basis" rule to the first $1.3 million of built in gains (total) passing to non-spouse beneficiaries and an additional $3 million of built in gains passing to a spouse. Previously these amounts were unlimited. All property transferred in excess of these values will retain a "Carry Over Basis." This could lead to significant income tax liability for beneficiaries wishing to sell such assets at a later date.
It is believed that Congress will act in early 2010 to eliminate this new tax regime and reinstitute the old Estate Tax arrangement, possibly making such changes retroactive to 1/1/10. Due to a quirk in the applicable law, even without Congressional action, the pre-2010 Estate Tax will return in full force on January 1, 2011 (with greatly increased tax rates and reduced exemption amounts). Please contact us for the latest information.
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. 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. Contact us now to set up a free consultation to discuss your personal situation.
Credit Shelter Trust
A person may leave a specified amount of assets ($3.5 million in 2009) 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. However, those assets will be subject to estate taxation upon the death of the spouse. If that is the case, the estate tax credit amount applicable to the estate of the first spouse is essentially wasted.
Both a Will and Revocable Living Trust can be drafted to include a Credit Shelter Trust, which is designed to "bypass" this problem. The trust is funded up to the estate tax credit amount upon death. 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.
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.