There are a number of estate planning methods you can use to minimize federal taxes on your estate. Brief overviews of some of these planning tools are outlined in the following paragraphs.
Giving away assets during your lifetime. Federal tax law generally allows each individual to give up to $12,000 (scheduled to be adjusted periodically for inflation) per year to anyone, without paying gift taxes, subject to certain restrictions. That means you can transfer some of your wealth to your children or others during your lifetime to reduce your taxable estate. For example, you could give $12,000 a year to each of your children, and your spouse could do likewise — for a total of $24,000 per year to each child. You may make $12,000 annual gifts to as many people as you wish. You may also give your child or another person more than $12,000 a year without having to pay federal gift taxes, but amounts in excess of $12,000 will count against the amount shielded from tax by your applicable credit. For example, If you (without your spouse) give your favorite niece $36,000 cash each year for three years, you will not necessarily have to pay taxes on those gifts, but you will reduce your available applicable credit amount by $24,000 each of those years ($72,000 in total).
Using the marital deduction to shield property from taxes. Federal tax law generally permits you to transfer assets to your spouse without incurring gift or estate taxes, regardless of the amount. This is not, however, without its drawbacks. Marital deductions may increase the total combined federal estate tax liability of the spouses upon the subsequent death of the surviving spouse. To avoid this problem, many couples choose to establish a bypass trust.
Bypass trusts or credit shelter trusts can give a couple the advantages of the marital deduction while utilizing the applicable credit to its fullest. Let’s say, for example, that a married couple has a federal taxable estate worth $4,000,000 (or $2,000,000 each). Using the marital deduction, if one spouse dies in 2008 the full $2,000,000 can be left to the other spouse without incurring taxes. But if the second spouse dies in 2008 and passes his or her $4,000,000 estate on to their children, taxes will be levied on the excess over the amount of assets shielded by the applicable credit ($4,000,000 – $2,000,000 = $2,000,000 subject to estate tax).
With a bypass or credit shelter trust, the first spouse to die can leave the amount shielded by the applicable credit to the trust. The trust can provide income and some limited access to principal to the surviving spouse for life; then, when the surviving spouse dies, the assets are distributed to beneficiaries, such as children. This permits the spouse who dies first to fully utilize his or her applicable credit. If the trust document is drawn properly, the assets in the trust are not included in the surviving spouse’s estate. Thus, the surviving spouse’s estate will be smaller and can also utilize the applicable credit. In the example above, the surviving spouse’s estate would not have to pay federal estate taxes. Because both partners have made use of their applicable credit, the couple is able to pass on a substantial estate to their beneficiaries, tax free.
Charitable gifts are not taxed as long as the contribution is made to an organization that operates for religious, charitable or educational purposes. Check to see if the organization you want to give money to is an eligible charity in the eyes of the Internal Revenue Service. You, or your estate, may be entitled to a tax deduction for contributions to a qualifying charity. Consult your tax advisor for specific details.
Life insurance trusts can be designed to keep the proceeds of a life insurance policy out of your estate and give your estate liquidity. Generally, you can fund a life insurance trust either by transferring an existing life insurance policy or by having the trust purchase a new policy. (Note that transferring an existing policy may have gift tax consequences—consult your tax advisor.) To avoid inclusion in your estate, such trusts must be irrevocable — meaning that you cannot dissolve the trust or change the terms of the trust if you change your mind later. With proper planning, the proceeds from life insurance held by the trust may pass to trust beneficiaries without income or estate taxes. This gives them cash, which may be used to help pay estate taxes or other expenses, such as debts or funeral costs.
Estate planning is very complex and is subject to changing laws. This article does not cover all aspects of estate planning. Be sure to seek professional advice from a qualified attorney, and perhaps a CPA. The money you spend now to plan your estate can mean more money for your beneficiaries in the end.
