What Is or Is Not Subject to Estate Tax
The Estate Tax includes, for example, what you own and also what is transferred as a result of your passing even if the assets are not subject to probate (Gross Estate): * face value of life insurance * value of retirement plans * property transferred by the decedent before death where the transfer was revocable * property the recipient could, through ownership, have possession only by surviving the decedent * annuities * assets passing by operation of law or survivorship * certain property transferred within three years of death Deductions include but are not limited to: * Funeral expenses, administration expenses, and claims against the estate; * Charitable contributions; * Property left to the surviving spouse (citizen); The calculation of Estate Tax starts with the Gross Estate and subtracts Deductions. Tax is levied on amounts above a personal exemption (currently unlimited in 2010 and resurfacing in 2011 at $1M).
Marital Transfers v. QTIP Trusts
MARITAL TRANSFERS. Lifetime gifts and bequests at death to one's spouse are subject to estate taxes (different result for non-citizen spouses). However, the estate of the spouse will have to pay estate taxes on the spouse's entire taxable estate, including the amount transferred to the spouse pursuant to the lifetime transfer, at the spouse's death. Accordingly, this tool merely defers estate taxes; it does not entirely eliminate them. QTIP TRUSTS. Included in a will, this trust holds assets for the 2nd-to-die spouse to use for life and then transfer to stated beneficiaries. These assets are not included in that spouse's estate. Therefore the value of this trust - tied to the federal personal exemption - allows the first estate to capture that personal exemption and reduces the overall marital community's estate tax by the tax on that exemption.
Each person can make annual gifts of, current for 2010, $13,000 to any number of persons without incurring a gift tax. If a husband and wife both engage in gifting, they can collectively give away $26,000 per year per recipient. Split gifts must be reported to the IRS on Form 709. Over a period of several years the amount of money that can be transferred to intended beneficiaries under this method is substantial, thereby reducing the size of the taxable estate. Currently the federal lifetime gift tax exemption is $1,000,000, which means that if you make a single gift in excess of $1,000,000 or a series of gifts that exceed this amount, then you will owe a federal gift tax at rates ranging from 18% up to 35% for the 2010 tax year. The lifetime gift tax exemption will remain at $1,000,000 in 2010. Two states also assess a gift tax - Connecticut and Tennessee - while Louisiana abolished its gift tax on July 1, 2008, and North Carolina abolished its gift tax on January 1, 2009.
Irrevocable Life Insurance Trusts (ILITs)
ILITs offer the opportunity of escaping taxes not just in one estate, but in several estates. The ILIT is typically a trust for the benefit of the spouse and/or children. An life insurance policy that is placed in an ILIT is considered to have no owner. Thus, once placed in an ILIT, you do not have the power to change or cancel the life insurance policy. If you already has a life insurance policy, ownership of the policy can be assigned (transferred) to the ILIT. This is done by signing an irrevocable assignment form available from the insurance company or from the agent. Proper completion of the form will indicate that the ILIT will be the new owner and the beneficiary. Remember that if the insured / transferor dies within three years of the date from which the policy was transferred, the life insurance proceeds will be included in the estate for tax purposes. The three-year concern can be completely avoided if the policy is purchased at the outset by the trustee of the ILIT.
Family Limited Partnerships (FLPs)
FLP is an industry term for a Limited Partnership that includes only family members. Like other limited partnerships, an FLP consists of two types of partners: general and limited. General partners control all management and investment decisions and bear 100% of the liability. Limited partners cannot participate in the management of the FLP and have limited liability. The partnership itself isn't taxable - instead, the owners of a partnership report the partnership's income and deductions on their personal tax return, in proportion to their interests. In an FLP parents (or grandparents) contribute assets in exchange for a small general partner interest and a large limited partner interest. They can then give portions of the limited partner interest to their children and grandchildren (usually to the annual gifting limit). This interest can go to the heirs directly, or be set aside in a trust. These transfers thus can reduce taxes through gifting without giving up control.
Charitable trusts must be established for charitable purposes, including: advancing education or religion; promoting health, civic responsibility or other goals beneficial to society; or, accomplishing governmental purposes. Trusts that qualify as charitable trusts may be perpetual, may substitute a new beneficiary if required to continue accomplishing the trust purpose, must be registered with the attorney general, and the attorney general may bring suit to enforce the trust. All beneficiaries of a charitable trust must be charitable, either a specific charity or an indefinite and sizeable class of beneficiaries. The grantor may receive a present tax deduction. The trust property is not included in the grantor's estate and the grantor's future creditors may not reach the assets, but the grantor has no further rights in the property. Thus, a charitable trust should only be created to satisfy charitable purposes and not as a method to avoid taxes and creditors.
Charitable Remainder Trusts (CRTs)
Unlike Charitable Trusts, the beneficiaries of a CRT need not all be charitable and may include the grantor. As of July 28, 1997, the charitable interest in the trust must be at least ten percent of the fair market value of all property transferred to the trust. CRTs are an irrevocable trust designed to convert an investor's highly appreciated assets into a lifetime income stream without generating estate and capital gains taxes. A CRT can potentially eliminate immediate capital gains taxes on the sale of appreciated assets, reduce estate taxes, reduce current income taxes with the corresponding income tax deduction, avoid probate and maximize the assets beneficiaries will receive after a grantor's death. CRTs can include unmarketable assets provided a qualified appraisal is performed whenever the trust is required to value the assets.
At the time of writing this Guide Congress has not yet passed anticipated Estate Tax regulation. The current estate taxes are nearing the end of the phased changes set forth in the Economic Growth and Tax Relief Reconciliation Act of 2001 ("2001 Act"). The 2001 Act gradually reduced the maximum estate tax rates from 50% in 2002, to the current rate of 45%. The amounts exempt from estate taxes increased from $1M in 2002 to $3.5M for 2009. The 2001 Act repealed the federal estate tax in 2010. Unless Congress acts to extend the tax relief offered by the 2001 Act, in 2011 the rates will return to pre-2001 Act levels which is $1M. Therefore, one of the best methods to decrease estate taxes is to influence Congress to extend the unlimited exemption or return it to a more reasonable level of at least $3.5M. Given what is included in a gross estate (don't make me quiz you), it does not take long to have a $1M taxable estate.