Estate Tax Reduction Techniques

Minimizing the amount of tax paid at your death by your estate is one of the most important components of estate planning.  Even if you do not think so, your estate may be liable for estate taxes.  Estate tax can be mitigated with proper planning (and only with proper planning).  This alert offers you an overview of some of the tax savings techniques estate planners deploy.

What is the estate tax?  
The estate tax is an inheritance tax payable from a deceased person’s assets before they are distributed to his or her beneficiaries.  It is part of the transfer tax system, which also includes the lifetime gift tax and the generation-skipping transfer tax (or “GST” tax).  Here in Massachusetts we are potentially subject to both federal estate tax and the separate Massachusetts estate tax, depending on how much property we amass during life and have in our names at death.

Tax is assessed when the assets being gifted or inherited exceed a certain amount.  There are separate federal and Massachusetts exemption amounts. Note that transfers to your spouse or to a charity are not subject to tax and the marital and charitable deductions are often key elements of estate planning.

It is tax season and this primer on estate tax planning would be remiss to leave out a quick discussion of the income tax consequences.  The estate tax and income tax systems intersect when the recipient/donee ultimately sells or otherwise disposes of the property he or she has received.  Inherited property’s cost basis is “stepped up” to date of death value while gifted property’s cost basis is “carried over” from the giver/donor.  When estate planning, one must always consider the income tax consequences of the plan on the recipient.

Do you need to think about estate tax planning?  In Massachusetts, there are more millionaires than one might expect given home values.  An expensive home coupled with a large insurance policy will put someone in the taxable estate category here in Massachusetts.

Some Ways to save on estate tax:

Marital planning 
If you are married, you should consider marital deduction planning. The key to marital deduction planning is to utilize both spouses’ exemption.  There are many ways to do this type of planning, which result in estate tax savings for married couples that get more of their assets to their chosen beneficiaries.  Most utilize trusts.

Gifting
An effective gifting strategy during life can result in a savings of both federal and Massachusetts estate tax.

Gifting can be done very simply.   You could start a practice of making rounds of annual exclusion gifts each year or pay your grandchild’s college tuition directly.

If you wish to embark on a grander scale of wealth transfer, you might choose a more high-level gifting strategy using a trust.  Some gifting techniques that use trusts include:

ILIT, or irrevocable life insurance trust, into which an insured can transfer ownership of his or her life insurance policy to keep the death benefit out of his or her estate.  Putting a $1,000,000 policy into an ILIT will get that $1,000,000 out to your beneficiaries tax free!

GRAT, or grantor retained annuity trust, is a great device to move appreciation on an asset that pops in value within the GRAT out to the beneficiaries (commonly the owner’s children) and out of the owner’s estate.

QPRT, a qualified personal residence trust, is a gift technique using a trust to move ownership of a personal or vacation residence to beneficiaries at a reduced rate.  For property that is not likely to be sold any time soon, a QPRT is an excellent way to move ownership of the property down to the next generation.

FLP, a properly structured “family limited partnership,” can allow an owner to effectively gift a valuable business asset in tax-efficient fashion, without relinquishing control.

GST Exempt Gift Trusts serves to enable a donor to put money in trust for multiple generations, sheltering both the principal amount of the trust and the growth on the assets within the trust, all outside of his or her estate.

Be flexible.
Trusts are incredibly flexible devices so your planner can craft a trust that will save your estates some tax and also accomplish your planning objectives for your loved ones.

Knowledge is power.
There’s a menagerie of estate planning techniques to consider and this quick summary gives you an overview, but does not provide advice tailored to your own situation.  Speak with your estate planner to find the right plan that will work for you!

Stay tuned for next week’s Part Three on the dual benefits of charitable giving – save estate taxes and get the personal benefits of philanthropy!   

If you have any questions about the information presented here, please contact Jennifer Fleming, the author of this alert at jfleming@princelobel.com.