Minimize Transfer Taxes
When an individual dies, the transfer of property to heirs is subject to federal estate taxation if the value of the estate exceeds a certain amount. The amount is $2,000,000 in 2006 to 2008, gradually increasing in following years. (The federal estate tax is currently scheduled for repeal for one year in 2010, resuming again in 2011.) Estate tax rates are significant. It gradually reduced to 45% in 2007, but is scheduled to jump to 55% in 2011 when the tax is reinstated. With no program in place to minimize estate taxes, the amount that ends up in Uncle Sam's coffers can be staggering. Here is a simplified example: In 2007 the top marginal rate is 45% and the exemption amount is $2,000,000. Assume a gross estate of $9,000,000, and no adjusted taxable gifts during life. Before determining the estate tax, other amounts are deducted, such as final expenses, debts of the decedent, and probate costs. Assume these total $500,000: | $10,000,000 | Estate Balance after Exemption | | - $500,000 | Expenses, Debts and Costs | | $9,500,000 | Estate Subject to Federal Taxation |
Then, the estate tax rate schedule is applied to determine the federal estate taxes due before credits: | $4,155,800 | Estate Tax Due Before Credits (2008) | | - $780,800 | Less: Estate Tax Credit (2008) | | $3,375,000 | Net Estate Tax Payable | | $6,125,000 | Balance Left for Heirs |
A variety of methods are available to help taxpayers minimize the transfer taxes due at death. One of these is a regular program of making nontaxable gifts to others during the taxpayer's lifetime, thus helping to deplete the amount of the estate remaining at death. Every taxpayer may give annually, to as many people as the taxpayer desires, gifts up to a specified amount. In 2007, the maximum amount is $12,000. This is known as the "gift tax annual exclusion," and it is only available for gifts of a present interest. The taxpayer's spouse likewise may give additional gifts up to the same amount annually. These gifts are free of the federal gift tax. (A few states also have gift taxes.) For example, in 2007 Taxpayer A decides to give gifts of $12,000 to each of her two children, to each of their spouses, and to each of her five grandchildren. She also decides to give $12,000 to her sister and $12,000 each to her two cousins. Altogether, she gives these 12 people $144,000. Now suppose Taxpayer A's spouse also wants to give the children, their spouses, and the grandchildren the maximum amount, totaling $99,000. In addition, the spouse wants to give his sister $5,000, for a total of $104,000. Together, the spouses have gifted $236,000 free of federal gift tax, and the heirs can enjoy part of their "inheritance" while the donors are still living. Moreover, Taxpayer A and spouse could do the same thing the next year and any year thereafter. The immediate rewards of gifting, for both donee and donor, are not the only advantage of this plan to minimize taxes. Looking toward the future when the taxpayer ultimately dies, the estate subject to taxation will have been reduced by the amounts given away, and growth of the estate is also reduced since a lesser amount has been earning interest or otherwise increasing in value. The goal is to keep the taxes due at death to a minimum through strategies that minimize the amount that will ultimately be taxed. Making lifetime gifts can be an effective strategy, but it must be done consistently in order to achieve the estate-reduction goal. One way to help ensure that a regular program of gifting occurs is to provide the gifts through an irrevocable life insurance trust. An irrevocable life insurance trust is a trust funded by a life insurance policy owned by the trust itself (not the individual who is insured, since this arrangement causes other unwanted tax consequences) and administered by a trustee. Every year, the taxpayer/insured person transfers up to the maximum tax-free gift amount to the trust. The trustee uses these amounts to pay the life insurance premiums. When the taxpayer dies, the proceeds are paid to the trust, free of both income and federal estate taxes if the trust is properly arranged. The trust holds and invests the proceeds for the benefit of trust beneficiaries. As long as the taxpayer does not exceed the gift tax annual exclusion amount per person, he or she may set up any number of such trusts naming certain individuals as the beneficiaries. The exact configurations, of course, will depend on the desires of the individuals involved. If done properly, the result is the desired one: reducing the amount of the estate that will be taxed, while creating a nontaxable trust to benefit the heirs. Lifetime gifts and irrevocable life insurance trusts are two popular methods for minimizing transfer taxes, but there are many others. For married couples, a marital transfer allows spouses to give to and receive from each other an unlimited amount of property without incurring any federal gift taxes. This includes any lifetime gifts as well as the transfer of estate assets when the first spouse dies. Ultimately, taxes become due on the estate only when the second spouse dies. Even then, there are strategies for minimizing the taxes due at the second death. Spouses may also use a bypass or credit shelter trust to minimize transfer taxes. Such a trust helps guarantee that the estate tax exemptions available to both spouses are fully utilized. Under this arrangement, when the first spouse dies, a portion of his or her estate (often an amount up to the exemption amount for the year of death) goes into a bypass trust. The surviving spouse can receive income for life from this trust. The remainder of the estate may be given outright to the surviving spouse or placed in a marital trust; in either event, the marital deduction shelters the transfer from federal estate tax. When the second spouse dies, any amounts left in the bypass trust are not included in the spouse's estate. Assets left in the marital trust, however, are included in the second spouse's estate. Here are some additional ways to minimize transfer taxes. - Charitable gifts - Such gifts can be made during the donor's lifetime or as a bequest to a charitable organization at death. Gifts made while the individual is living provide an income tax deduction as well as the future reduction of the estate. Another option allows the donor to irrevocably transfer property using a charitable gift annuity, in return for which the charity provides a lifetime income for the donor or other beneficiary. A portion of these income payments is received income-tax free.
- Private annuities - This type of annuity often involves two generations where, for example, a father might sell an asset to an adult child in return for an unsecured promise to pay a regular annual amount to the father for the father's lifetime. Because the asset is removed from the father's estate, it will not be subject to estate taxation.
- Installment sale - Another arrangement often used between family members is an installment sale to an adult child or other heir. In this case, the asset is given in return for a promissory note from the child, and is moved from the seller's estate to the buyer's estate.
- Some methods for minimizing transfer taxes are fairly simple to establish and execute, while others are complex in varying degrees. All such arrangements require careful planning and the assistance of professional advisors to be certain the desired results are achieved.
The method that is best for any particular individual must be determined by a careful analysis of the individual's current financial situation, as well as future goals for personal use of financial assets and goals for disposition of the estate at death. |
