CAUTION: THE FOLLOWING INFORMATION IS FOR GENERAL ENLIGHTENMENT ONLY. FOR ADVICE REGARDING YOUR PARTICULAR NEEDS CONTACT A QUALIFIED ATTORNEY IN YOUR AREA.
Planning Ideas for Large Estates
GIFTS MADE DURING LIFETIME OF THE DONOR/OWNER
CHARITABLE GIVING TECHNIQUES TO MINIMIZE FEDERAL ESTATE TAXES
GIFTS THAT ARE MADE AFTER THE DEATH OF THE OWNER
ESTATE TAX SAVINGS IDEAS
FOR LARGE ESTATES
The following summary of ideas is provided to give you an overview of some of the methods of minimizing estate/gift tax that can be used by persons whose estates exceed the amount that can be protected by the $1,000,000.00 estate tax exemption. (It is one tax and it is referred to as "gift tax" on gifts made during lifetime and "estate tax" on transfers made after death.)
Some of the ideas are simple, and some are very complex.
GIFTS MADE DURING LIFETIME OF THE DONOR/OWNER
Any individual (donor) can transfer up to $11,000.00 annually to any number of persons (donees) totally free of gift taxes. For example, you could transfer $11,000.00 each year to any number of persons. Such transfers would deplete your estate of assets which otherwise could be subject to estate tax upon your death. This is known as the "annual gift exclusion."
Using the $11,000.00 per year annual exclusion allows you to get significant amounts of assets out of your estate and also keeps appreciation of the gifted assets out of your estate. Once a gift is complete, income produced by the gift is taxed to the recipient rather than to the donor. Usually the recipient is in a lower income tax bracket than the donor, so this saves income tax.
If you are married, you and your spouse can give $22,000 to as many people as you wish, even if only one of you has the ability to make such gifts. The spouse must join in the gift making.
Making Larger Gifts (and Paying Some Gift Tax Now).
You may want to consider making larger gifts if you have assets that are expected to appreciate significantly in value. By making the gift, you will get the asset and the future appreciation out of your estate.
On the other hand, if your asset has already appreciated, it may be wiser to keep the asset and let your beneficiary inherit it. Assets that are received by inheritance, instead of by a gift during the lifetime of the owner, receive a step-up in basis and thus tax on the appreciation can be avoided.
Gifts for Tuition and Medical Care.
Tuition payments made by an individual directly to a college or university attended by a beneficiary are not subject to gift tax, nor are they included in the $11,000.00 annual gift exclusion. This is an excellent vehicle for paying for a college education for those whom you wish to benefit.
The payment is limited solely to tuition (not books, room, board, etc.), and the payment must be made directly to the institution rather than to the beneficiary.
Also, payments made to a health care provider for a beneficiary's medical care receive similar gift-tax exempt treatment.
Gift of Residence In Trust (GRIT)
By means of a Gift of Residence In Trust (GRIT), a person (the donor) can transfer his/her personal residence to a trust and yet continue to live in the residence rent free for a pre-selected number of years. At the end of the period, title passes to the named beneficiary.
For gift tax purposes, the donor can deduct from the value of the gift the value of the right to live in the residence for the chosen number of years. This substantially reduces the amount of the gift, depending upon the term and the age of the person making the gift.
Often the transaction can be formulated in such a manner that the value of the gift is less than the givt tax credit so there will be no transfer tax consequences whatsoever. If the value of the residence appreciates over the term, both the residence and the appreciation pass to the beneficiary at a substantial tax savings.
Grantor Retained Annuity Trust (GRAT)
The individual Grantor transfers income-producing assets to a trust. During the term of the trust, the Grantor receives a fixed annual income stream (the annuity) from the trust. At the end of the period, the property passes to the named beneficiaries.
Using a federally determined interest rate, the present value of the income stream is calculated. For gift tax purposes, the present value of the income stream is subtracted from the present value of the asset. The result is the value of the gift of the remainder interest to the ultimate beneficiary. This can lead to gift values that are very small relative to the asset value transferred. If the GRAT assets are those which have a potential for appreciation, the appreciation is also transferred to the beneficiary at a greatly reduced or eliminated gift tax cost.
A family partnership is an extremely effective planning vehicle that enables an individual to transfer assets to others, usually family members, during his/her lifetime while retaining control of the asset. A family partnership can hold a variety of assets, including real property interests, stock of closely held operating businesses, marketable securities, etc.
The partnership is set up in such a way that the senior generation member usually holds a 5 percent interest as the general partner, and the remaining 95 percent as a limited partner. The limited partnership interests are then available for annual gifting to younger generation members. The gifting transfers the right to receive income but not control. Substantial valuation discounts (from 15 percent to 45 percent of the underlying asset value) are available, depending upon the nature of the underlying assets. These discounts can substantially reduce the value of the partnership, resulting in a reduced estate tax on the donor's death.
Installment Sales to Children/Key Employees.
The owner of a closely held business can sell the voting stock in the business to his beneficiaries or key employees. The sale can take place at one time or in a series of transactions. due to lack of marketability of closely held stock and minority interest discounts, the sale price can usually be an amount which is substantially less than the fair market value of the corporate stock or underlying assets of the business taken as a whole.
Another major advantage is the transfer of the future appreciation in the value of the corporation to the beneficiaries/key employees. This removes that appreciation from the original owner's estate but still allows the original owner to retain control of the corporation. If the seller wishes, payment on the notes by the beneficiaries/key employees can be made part of an annual gift program and forgiven each year up to the amount of the $11,000.00 annual gift tax exclusion, thus removing additional assets from taxation in the donor's estate.
A significant advantage to choosing to pay gift tax now rather than to pay estate tax at death is that tax on a lifetime gift actually ends up to be much less than on a transfer made at death. This is because the gift tax is an exclusive tax – gifts made during life are taxed only on the amount received by the donee minus the gift tax paid. In contrast, estate tax is a inclusive tax – the entire amount transferred plus the tax paid on that gift is included in the estate tax calculation.
CHARITABLE GIVING TECHNIQUES TO MINIMIZE FEDERAL ESTATE TAXES
Under the right circumstances charitable giving is a win-win arrangement for everyone. Gifts to a charity may qualify for substantial current income tax deductions based on the current fair market value of the asset (not just your basis in highly appreciated assets), substantially increase your cash flow and avoid tax on capital gains. These advantages are available because the charity (which is exempt from paying taxes) can sell the asset, avoid tax on the capital gains and invest the entire proceeds in investments that may offer a higher yield.
Charitable giving is a very exciting and rewarding area of estate planning. It can be used to assist a donor in diversifying his/her portfolio and avoid tax on the restructuring of the portfolio, to avoid capital gains tax on the sale of a business, achieve tax-advantaged solutions for overfunded pension plans, build a large retirement fund and avoid the restrictions and limitation of the usual qualified retirement plans, and to make a gift to a sibling or other loved one an avoid estate tax in the recipient’s estate. It can also transform an illiquid asset into a source of cash to provide income to dependent parents or loved ones, pay educational expenses for a child or grandchild, fund long-term care needs and purchase life insurance. Read on and see if your circumstances are appropriate.
An asset is transferred to a trust of which the grantor retains the right to receive income for life, with the asset passing to a charity following the grantor's death. Even though the charity will not receive anything for many years, the grantor can take an immediate income tax deduction for the charitable gift when the trust is established. If appreciated assets are transferred to the trust, the trust can sell the asset and avoid what otherwise could be a substantial capital gains tax to the grantor under present law, thus freeing up more principal for reinvestment and lifetime income to the grantor.
The donor may choose to set up a charitable remainder annuity trust (which pays a fixed annuity payout) or a charitable remainder unitrust (which pays an income based on a fixed percentage of the value of the trust assets. No additional
contributions are allowed to a charitable remainder annuity trust, but subsequent contributions can be made to a charitable remainder unitrust.
This trust provides an income to the charity for either the life of one or more persons or for a specified number of years. At the end of the person’s life or at the end of the time specified, the principal either goes back to the donor or to someone chosen by the donor.
This is a trust that is set up and maintained by a charitable organization. It is established to receive contributions from many donors. When a donor transfers assets to the fund, the donor gets an income for life (either the donor’s life or for the life of other individuals). Whatever is left when the persons who are entitled to income for life pass away goes to the charitable organization.
The donor transfers an asset directly to the charitable organization. The charitable organization pays the donor an annuity for life (it can also be set up for the lives of two persons). The donor receives an income tax deduction based on the excess of the value of the contribution over the value of the annuity.
Gift Of A Life Insurance Policy To A Charitable Organization.
A gift of a life insurance policy is one of the simplest ways to make a charitable contribution. The donor can obtain a great deal of pleasure knowing that he/she is making a significant gift to the charity of choice for a relatively small annual tax-deductible contribution.
A life insurance policy will create a large pool of money for a small outlay. In addition, it creates little administration effort by the charity, the charity can obtain the proceeds promptly (without delays created by wills or trusts), there is no reduction in the gift due to probate, estate taxes or other administration expenses, the charity will not lose the gift if the donor decides to move away. The charity can also access the cash values and dividends if the need arises during the donor’s lifetime. It can provide a source of emergency funds.
Donation of a life insurance policy can turn a modest donor into a big donor.
Remainder Interests In A Farm Or A Residence.
The donor transfers title to the personal residence or farm to the charity and retains the right to occupy the property for life or for a term of years. A gift of only a portion of the residential property or farm can also be made under this arrangement.
This is part gift and part sale to a charitable organization. The asset is sold to the charity at less than its fair market value. Tax laws currently require that the donor’s basis in the asset be allocated between the sale and gift portions, so the donor would realize a gain on the sale portion of this transaction.
This arrangement provides for the donor and his/her heirs to maintain maximum control over the use of charitable gifts. There are two kinds of family foundations -- the private foundation and the supporting organization. The private foundation has been the subject of numerous limitations and regulations since 1969. The supporting organization allows the family foundation to come under the tax and administrative umbrella of a public charity and qualify as a charity for many tax purposes.
Tax-Favored Insurance Products (Sometimes Called the 1% Solution)
These policies do not actually reduce estate taxes, they pay the tax using income tax free, discounted dollars. They can save an estate enormous amounts of money and inexpensively provide liquidity to pay estate taxes.
There are many types of policies available. Each is designed to meet specific needs. Two of the most common policies used in estate planning are Joint first-to-die policies and Second-to-die policies. A first-to-die policy covers two or more lives and pays at the first death. This is used when taxes must be paid upon the first death or when income is needed after the first death to provide ongoing financial support for dependents or business partners. The Second-to-die policy is used to minimize the estate tax impact at the second death.
Both types of policies are valuable for persons who want to accumulate large cash values in their policies (which grow income tax deferred at competitive money market rates, are free of reinvestment worries, and can be withdraw income tax free by using policy loans at favorable interest rates. This means that many individuals who would normally have a difficult time qualifying for insurance or who would not qualify at all for a single life policy are able to obtain insurance coverage.
Are You Concerned That One Spouse Is Uninsurable?
Another time in which second-to-die policies are extremely useful is when one of the spouses is uninsurable. Since the insurance company will not have to pay until the death of the second insured, the underwriting is considerably more lenient than it is on a single life policy.
A couple can take approximately 1% of their net worth every year for approximately 10 to 12 years and purchase a second-to-die life insurance policy. The proceeds are used to fund estate settlement costs and liquidity need. This plan results in a total outlaw of 10% to 12% of the cash required to pay estate expenses.
Of course, if the insureds die during the first 10 to 12 years, their total cash outlay may be substantially less than the originally projected amount. This is because life insurance is designed to "pay off" on the insureds’ death, whether only one premium or many premiums have been paid. Life insurance is a unique took and can provide stability to estate planning.
Another important feature available with most policies is the option to have premiums waived if the insured becomes totally disabled.
The face value of any life insurance policy in which the insured has any "incidents of ownership" is included in the insured's gross estate and is subject to federal estate tax. "Incidents of ownership" include the right to borrow on the cash value of the policy and the right to designate the beneficiary of the policy. The face value of the policy could be taxed up to the 55 percent maximum rate.
This result can be avoided by the insured transferring the ownership of the policy during his/her lifetime to an irrevocable life insurance trust of which an independent person is the trustee. Because the trust (not the insured) is the owner, the death benefits are not taxed at the insured's death. The death benefits are thus available at full face value in the life insurance trust either for the beneficiary or as a source of cash to pay federal estate taxes on other taxable assets.
GIFTS THAT ARE MADE AFTER THE DEATH OF THE OWNER
It is possible to obtain significant estate tax savings by using some of the above ideas in a manner that will become effective only after the owner dies.
Pay On Death Arrangements and Beneficiary Designations.
Many accounts in banks and financial institutions can be held
in a form which designates a beneficiary to whom the institution should pay the balance of the account upon the death of the original owner. This manner of holding title leaves the owner in complete control during his/her lifetime, and passes whatever is left in the account to the designated beneficiary. This avoids probate, and if the designated beneficiary is a tax-exempt organization, estate taxes will also be avoided.
Testamentary Charitable Remainder Trusts.
The advantages of creating a charitable remainder trust during your lifetime are mentioned above. It is possible to avoid the complexity during the owner's lifetime but still obtain the estate tax savings by including charitable remainder trusts in the final distribution of your estate. This would mean that your beneficiaries would receive income for the rest of their lives, and whatever is left after they die would go to tax exempt organizations of your choice.
A portion of your estate can be set aside into a special trust that will pay income to your current spouse for as long as he/she lives. Upon his/her death, the principal is paid to your chosen beneficiaries, such as children of your prior marriage.
The assets that go into this type of trust (known as a Qualified Terminable Interest Property (QTIP) Trust), are taxed at your surviving spouse’s death, but no tax is paid when the trust is funded for your surviving spouse’s benefit.
If you would like to discuss these possibilities for preserving your estate for those to whom you want it to pass, give me a call at (619) 696-9973, or send e-mail to attorneysickler@yahoo.com to make a convenient appointment. I look forward to hearing from you.
Sandra D. Sickler