"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.
Here's what you can do to cut him out of your will:
Step 1: Make maximum use of your "applicable exclusion amount." This is the maximum combined amount (other than gifts or bequests to charities or your spouse) that you can give away during your lifetime or pass to your heirs at death without having to pay a gift or estate tax. In 2003, this amount is $1,000,000. Under the new Tax Act, it will rise to $1,500,000 in 2004 for estate tax, but not gift tax, purposes.
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 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 marriage.
Marital Trusts are also useful if professional asset management is desired and to protect assets from any creditors of the surviving spouse.
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 of even relatively modest means has to worry about estate taxes if he or she owns substantial life insurance.
For example, if a single person owning just $600,000 in assets dies in 2003 owning a $1,000,000 life insurance policy payable to his or her children, then the estate taxes will be based on $1,600,000, which under current law will be $255,000!
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 protects the proceeds from your spouse's creditors.
A more detailed discussion of the use of Irrevocable Life Insurance Trusts is available here.
Step 3: Reduce your taxable estate by making annual gifts. You can give up to $11,000 each year to each of your children, grandchildren, or anyone else for that matter without using 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: Leverage your gifting and reduce the taxable value of assets in your estate by taking advantage of valuation discounts that may be available. This is often done by means of a Family Limited Partnership.
Step 5: If Steps 1 through 4 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 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 2003 is $1,120,000 ($2,240,000 for married couples with proper planning).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 repealing the estate tax, but with proper planning, maybe you can!