Understanding
Estate Taxes
Strategies To Reduce Or Eliminate Your Estate Taxes
1.
Who has to pay estate taxes?
2. How is the net value of my estate determined?
3. How can I reduce or eliminate my estate taxes?
4. Using Both Exemptions
5. Removing Assets From Your Estate
6. Tax-Free Gifts
7. Irrevocable Life Insurance Trust (ILIT)
8. Qualified Personal Residence Trust (QPRT)
9. Grantor Retained Annuity Trust (GRAT) and Grantor Retained
Unitrust (GRUT)
10. Family Limited Partnership (FLP)
11. Charitable Remainder Trust (CRT)
12. Charitable Lead Trust (CLT)
13. Buying Life Insurance
14. How To Reduce or Eliminate Estate Taxes Summary Chart
1. Who has to pay estate taxes?
Depending on how much you own when you die, your estate may have to pay
estate taxes before your assets can be fully distributed. Estate taxes
are different from, and in addition to, probate expenses (which can be
avoided with a revocable living trust) and final income taxes (on income
you receive in the year you die). Some states also have their own death/inheritance
taxes.
Federal
estate taxes are expensive--they now start at 41% and quickly go up, to
49% in 2003. And they must be paid in cash, usually within nine months
after you die. Since few estates have this kind of cash, assets often
have to be liquidated. But estate taxes can be substantially reduced or
even eliminated--if you plan ahead.
Your
estate will have to pay estate taxes if its net value when you die is
more than the "exempt" amount set by Congress at that time.
Here is the current schedule:
Year of Death.........“Exemption” Amount
2006, 2007 & 2008....$2 million
2009........................$3.5 million
2010........................N/A (repealed)
2011........................$1 million
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2. How is the net value
of my estate determined?
To determine the current net value, add your assets, then subtract your
debts. Include your home, business interests, bank accounts, investments,
personal property, IRAs, retirement plans and death benefits from your
life insurance.
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3. How can I reduce or
eliminate my estate taxes?
In the simplest terms, there are three ways:
1. If you are married, use both estate tax exemptions.
2. Remove assets from your estate before you die.
3. Buy life insurance to pay remaining estate taxes.
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4. Using Both Exemptions
If your spouse is a U.S. citizen, you can leave him or her an unlimited
amount when you die with no estate tax. But this can be a tax trap, because
it wastes an exemption.
Let's
say, for example, that Bob and Sue together have a net estate of $2 million
and they both die in 2003. Bob dies first. He leaves everything to Sue,
so no estate taxes are due on his death. When Sue dies, her estate of
$2 million uses her $1 million exemption. The tax bill on the remaining
$1 million? $435,000!
But
if, instead, Bob and Sue plan ahead, they can use both their exemptions
and pay no estate taxes. A tax-planning provision in their living trust
splits their $2 million estate into two trusts of $1 million each. When
Bob dies, his trust uses his $1 million exemption. When Sue dies, her
trust uses her $1 million exemption. This reduces their taxable estate
to $0, so the full $2 million can go to their loved ones. A $435,000 savings!
If
you are married and qualify for the family business deduction, this arrangement
will let you and your spouse leave your family up to $2.6 million estate
tax-free.
This
planning can also be done in a will, but you would not avoid probate or
enjoy the other benefits of a living trust.
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5. Removing Assets From
Your Estate
An effective way to reduce estate taxes is to reduce the size of your
estate before you die. So, spend some and enjoy it!
Also,
you probably know to whom you want to direct your assets after you die.
If you can afford it, why not give them some assets now and save estate
taxes? It can be very satisfying to see the results of your gifts--something
you can’t do if you keep everything until you die. Appreciating
assets are usually best to give, because the asset and future appreciation
will be out of your estate.
Assets
you give away keep the original cost basis (what you paid), so the recipients
may have to pay capital gains tax when they sell. But the top capital
gains rate is only 15% (assets held at least 12 months). That's a lot
less than estate taxes (45%) if you keep the assets until you die.
Some
of the most commonly-used strategies to remove assets from estates are
explained below. Note that these are all irrevocable, so you can't change
your mind later.
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6. Tax-Free Gifts
This is easy and it doesn't cost anything. Each year, you can give up
to $12,000 ($24,000 if married) to as many people as you wish. So if you
give $12,000 to each of your two children and five grandchildren, you
will reduce your estate by $84,000 (7 x $12,000) a year; or $154,000 if your
spouse joins you. (This amount is now tied to inflation and may increase
from year to year.)
You
can give more, but it will use up some of your estate tax exemption. That's
because it's a combined gift and estate tax exemption. While you're living,
it’s a gift tax exemption; after you die, it’s an estate tax
exemption.
Charitable
gifts are unlimited. So are gifts for tuition and medical expenses if
you give directly to the institution.
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7. Irrevocable Life Insurance Trust (ILIT)
An easy way to remove life insurance from your estate is to make an ILIT
the owner of the policies. As long as you live three years after the transfer,
the death benefits will not be included in your estate. Usually the ILIT
is also the beneficiary of the policy. When you die, the money can provide
for your spouse, children or others according to the instructions you
put in the ILIT when you set it up.
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8. Qualified Personal
Residence Trust (QPRT)
A QPRT lets you save estate taxes by removing your home (a substantial
asset) from your estate now; yet you can continue to live there. Here's
how it works.
You
transfer your home to a trust for a period of time, usually 10 to 15 years.
During this time, you continue to live in your home. When the trust term
ends, title to your home transfers to the trust beneficiaries, usually
your children. If you wish to stay there longer, you may make arrangements
to pay rent. If you die before the trust ends, your home will be included
in your estate, just as it would had you never set up a QPRT.
There's
more. A QPRT "leverages" your estate tax exemption. Since your
children will not receive the house until the trust ends, its value as
a gift is reduced. For example, if the current value of your home is $250,000
and you put it in a QPRT for 15 years, its value for tax purposes could
be as little as $75,000. That leaves much more of your exemption for other
assets.
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9. Grantor Retained Annuity Trust (GRAT) and Grantor Retained
Unitrust (GRUT)
These are much like a QPRT. The main difference is that a GRAT or GRUT
lets you transfer an income-producing asset (stock, real estate, business)
to a trust for a fixed number of years, removing it from your estate,
and still receive the income. (If the income is a set amount, the trust
is called a GRAT. If the income fluctuates, it's called a GRUT.)
When
the trust ends, the asset will go to the beneficiaries (usually your children).
Since they will not receive it until then, the value of the gift is reduced
for tax-planning purposes, which is an advantage for you. If you die before
the trust ends, the asset will be in your estate.
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10. Family Limited Partnership
(FLP)
An FLP lets you reduce estate taxes by transferring assets such as a family-owned
business, farm, real estate or stocks to your children now -- yet you
keep full control.
For
example, you and your spouse can set up an FLP and transfer assets to
it. In exchange, you receive partnership shares. You control the general
partner shares and can give limited partner shares to your children, removing
up to 99% of the value of the assets from your taxable estate.
Because
you control the general partner shares, you have full control of the FLP.
Limited partners (your children) have none. Their shares cannot be sold
or transferred without your approval. And because there is no market for
these shares, their value is highly discounted. So you can transfer the
assets to your children at a reduced value—without losing control.
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11. Charitable Remainder
Trust (CRT)
A CRT lets you convert a highly appreciated asset (like stocks or investment
real estate) into a lifetime income without paying capital gains tax when
the asset is sold. It also reduces your income and estate taxes and lets
you benefit a charity that has special meaning to you.
With
a CRT you transfer the asset to an irrevocable trust. This removes the
asset from your taxable estate. You also receive an immediate charitable
income tax deduction.
The
trust then sells the asset at market value, paying no capital gains tax,
and reinvests in income-producing assets. For the rest of your life the
trust pays you an income. Since the principal has not been reduced by
capital gains tax, you can receive more income over your lifetime than
if you had sold the asset yourself, paid the capital gains tax, and then
reinvested the smaller amount. After you die, the trust assets go to the
charity you have chosen.
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12. Charitable Lead
Trust (CLT)
A CLT is just about the opposite of a CRT. You transfer an asset to the
trust, which reduces the size of your taxable estate. But instead of paying
the income to you, the trust pays it to a charity for a set number of
years or until you die. Then the trust assets will go to your spouse,
children or other named beneficiaries.
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13. Buying Life Insurance
Depending on your age and health, buying life insurance can be an inexpensive
way to pay estate taxes. Also, the three-year rule mentioned earlier does
not apply to new policies. But don't be the owner of the policy—that
will increase your taxable estate and your estate taxes. To keep the death
benefits out of your taxable estate, set up an ILIT and have it purchase
the policy for you.
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14. How To Reduce or Eliminate Estate Taxes Summary Chart
a. If Married, Use Both Exemptions
(Living Trust with Tax Planning)
• Uses both spouses' estate tax exemptions
• Protects up to $2.6 million from estate taxes (for family businesses
that qualify)
b.
Remove Assets From Estate
(Make Annual Tax-Free Gifts)
• Simple, no-cost way to save estate taxes by reducing size of estate
• $11,000 ($22,000 if married) each year per recipient (amount now
tied to inflation)
• Unlimited gifts to charity and for medical/educational expenses
paid to provider
(Transfer
Life Insurance Policies to Irrevocable Life Insurance Trust)
• Removes death benefits of existing life insurance policies from
estate
• Included in estate if you die within 3 years of transfer
(Qualified
Personal Residence Trust)
• Removes home from estate at discounted value
• You can keep living there
(Grantor
Retained Annuity Trust / Grantor Retained Unitrust)
• Removes income-producing assets from estate at discounted value
• You can continue to receive income
(Family
Limited Partnership)
• Discounts value of business, farm, real estate or stock
• Lets you start transferring assets to children now to reduce your
taxable estate
• You keep full control
(Charitable
Remainder Trust)
• Converts appreciated asset into lifetime income with no capital
gains tax
• Saves estate taxes (asset out of estate) and income taxes (charitable
deduction)
• Charity receives trust assets after you die
(Charitable
Lead Trust)
• Removes asset from your estate, saving estate taxes
• Income goes to charity for set time period, then trust assets
go to loved ones
c.
Buy Life Insurance
(Through Irrevocable Life Insurance Trust)
• Can be inexpensive way to pay estate taxes
• Death benefits not included in your estate
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NOTE:
This information is designed to provide a general overview with regard
to the subject matter covered and is not state-specific. The authors,
publisher and host are not providing legal, accounting or any other advice
which purports to be specific to your situation. The contents of this
website are believed to be completely reliable. Nevertheless, some material
may be affected by changes in the laws or interpretations of such changes
since the material was entered on the website. If legal advice or other
expert guidance is required, the services of a competent professional
in the field of law, accounting, insurance or investments should be sought.
Price
& Farrington, PLLC - Attorneys and Counselors
at Law
12501 Bellevue-Redmond Road, Suite 215 ....Bellevue,
Washington 98005
Phone: 425.451.3583.. Fax: 425.452.0153 ..E-mail: contact@pricefarrington.com
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