Pass Maximum Wealth to Your Heirs

1. Introduction

Today’s seniors, as a population, are the wealthiest generation in our nation’s history. This means that more wealth is likely to pass from one generation to the next in the next two decades than ever before. As most of you know, our internal revenue code taxes such transfers.

Under current law the most significant tax burden often will result via the estate tax imposed at death rather than via the income taxes imposed during life. We therefore wish to present a brief summary of certain estate planning concepts and techniques that might be of interest to you.

2. Estate Planning Concepts and Techniques

a. The Revocable Living Trust

Although not specifically regarded as a tax-saving device, the revocable living trust is a valuable estate planning technique, used primarily to avoid the inconvenience and extra costs of a probate administration of an estate upon death.

In addition, property held in a revocable living trust will qualify for the full “step-up” in basis upon the death of the first spouse. You therefore should consider using this device as your primary estate planning vehicle.

b. Community Property vs. Joint Tenancy

For income tax purposes, both “halves” of community property owned by a husband and wife receive a “step-up” in basis upon the death of either spouse. Because only one-half of the basis of the property held in joint tenancy receives a basis “step-up” at the death of the first spouse, it is generally recommended that legal title to appreciated assets be held as “community property” rather than as “joint tenants.”

c. The $675,000 Lifetime Exemption

Make sure you take advantage of the $675,000 “lifetime exemption” granted to each person (via the “unified credit”) by either making gifts in that amount during life or by establishing a $675,000 “Exemption” (or “Bypass” or “Credit Shelter” or “Residual”) Trust at death.

After your cumulative lifetime and testamentary transfers exceed $675,000, gift and/or estate taxes (“transfer taxes”) are imposed at marginal rates ranging from 37% to 55%. By making significant lifetime gifts, your heirs (or “beneficiaries” or “donees”) will receive all future appreciation of the transferred property free of transfer taxes.

If your aggregate gifts do not exceed $675,000 ($1,350,000 for a married couple), no gift tax will be payable at the time of the gift. If you make gifts in excess of $675,000, your transfer tax payment will be accelerated, but your gift tax dollars generally will not be subject to transfer taxes.

Certain valuation advantages (such as “minority” discounts) also are possible in connection with lifetime gifts.

d. The $10,000 Annual Exclusion

A lifetime gift-giving program could reduce your overall estate and gift tax costs considerably. Every individual may transfer cash or other property worth $10,000 each year to each of as many donees as the donor selects without incurring any current gift or later estate tax.

You may make these gifts (known as “annual exclusion” gifts) outright or via trusts, although careful planning is needed if trusts are to be used. For example, it is very important to assure that any trust for a grandchild contain special provisions in order to ensure that gifts made to that trust are exempt from the “generation- skipping” tax.

e. The $1,000,000 Generation-Skipping Exemption

The “generation-skipping transfer” (GST) tax enacted in 1986 generally imposes an additional transfer tax (at a 55% rate) on property transferred to grandchildren by lifetime gift or at your death, and whether outright or via trust. You may take advantage of certain techniques to avoid or substantially reduce this GST tax.

One technique involves an “annual exclusion” gift program to grandchildren (either outright or via trust). Another technique involves use of your $1,000,000 lifetime GST exemption (different from your $675,000 “unified credit” for gift and estate tax purposes) to establish a “dynasty trust” (which often invests in life insurance polices) to enable a substantial amount of property to pass to grandchildren, great-grandchildern, and perhaps later generations free of any estate or GST tax.

You also may wish to include in your estate plan a special GST marital deduction provision to assure that both spouses can use their respective $1,000,000 GST exemptions.

f. The Qualified Domestic Trust

Most married couples combine the $675,000 lifetime exemption (“unified credit”) with the unlimited marital deduction to assure that no estate taxes are payable until the death of the surviving spouse.

The unlimited marital deduction generally is available for gifts and bequests to spouses. Gifts and bequests can be outright transfers or can be made via trusts (although not all types of trusts will qualify for the marital deduction).

Recent tax law changes impose severe restrictions on the ability to defer estate taxes if the surviving spouse is not a United States citizen (the surviving spouse's residence is not a factor). Under the new rules, property passing to the non-citizen surviving spouse must be held in a new type of trust (a “qualified domestic trust”) in order to qualify for the marital deduction.

The most recent requirements for these trusts are contained in the Revenue Reconciliation Act of 1990.

g. The Life Insurance Trust

All estate tax on life insurance proceeds may be avoided on the death of the insured through proper planning. Insurance proceeds can be available free of estate tax to the surviving spouse, but by designating other family members or a trust for their benefit as owners and beneficiaries, estate taxes can be avoided in both spouses' estates.

New “joint life” (or “survivorship” or “second to die”) policies make life insurance planning affordable for many more people. You should consider the ownership and beneficiary designations for any newly acquired life insurance carefully before the policy is purchased. You also should review the ownership and beneficiary designations of your existing policies.

h. The Charitable Remainder Trust

There are several techniques that you can use to transfer significant wealth to family members in a tax-favored manner and at the same time benefit charity. This is particularly true if you contemplate a sale of highly appreciated assets. You also may be able to arrange to receive a lifetime annuity for promising to transfer your residence to a charity at your death.

i. The Family Limited Partnerships

An increasingly popular estate planning tool is the Family Limited Partnership (FLP). It is extremely valuable, especially for clients who own appreciating assets, such as real estate and growth stocks.

A Family Limited Partnership operates very much like other limited partnerships except that only family members will own partnership units in the Family Limited Partnership.

In the initial stages, you and your spouse will own all of the partnership units, both General and Limited. The plan would be for you to divest yourself of the Limited Partnership units by using your annual exclusion and/or the unified credit exemption.

You, the owner of the General Partnership Units will control the partnership. Control includes the rights to buy, sell and otherwise dispose of the property held within the partnership. Control also provides the ability to dictate partnership distributions. This also means that you can be paid a “management fee” equal to the amount by which the partnership's income exceeds the expenses.

j. The Grantor Retained Income Trust

GRITs, GRATs and/or GRUT's are irrevocable trusts into which you may place highly appreciating assets and retain the income (or the use of the property) for a fixed period of years. Principal, at the end of the specified period of years, will pass to your designated beneficiary, such as a child or grandchild.

If you survive the period of years selected, significant estate, gift, and generation-skipping transfer tax savings, as well as other transfer cost reductions, may be realized.

k. The “Buy-Sell” Agreements/Options

A “Buy-Sell” or option agreement (whereby a person grants to a family member the right to acquire assets at an established price) can be used to advantage to establish the value of an asset for estate tax purposes.

This estate planning device now is subject to new restrictions, but these restrictions do not apply to agreements made before October 9, 1990.

You therefore should be very careful if you wish to modify “Buy-Sell” or option agreements made prior to October 9, 1990.

l. The Private Annuity

An individual in poor health and not expected to survive for his or her actuarial life expectancy can sell assets to beneficiaries (usually children) in exchange for the beneficiaries' promise to make fixed annuity payments to the individual for the individual's life.

Because the value of the annuity to be received will be based on the individual's actuarial life expectancy, in most cases “private annuity” transactions can reduce transfer taxes substantially.

m. “S” Corporations

Recent income tax law changes have made the use of “S” corporations more valuable. Upon the death of an “S” corporation shareholder, “S” corporation status can be lost unless the decedent's “S” corporation shares pass to a qualified shareholder in a timely manner.

All “S” corporation shareholders therefore should assure that their estate plans allow for the continuation of “S” corporation status.

n. The Durable Power of Attorney

It is becoming more important to plan for the risk of lifetime incapacity. A Durable Power of Attorney can provide lifetime asset management, especially if your estate plan does not include a revocable living trust.

A Durable Power of Attorney for Health Care permits you to designate someone to make health care decisions on your behalf if you become unable to do so, and also enables you to express your desires with respect to those decisions under various circumstances.

o. The Living Will

A “Directive to Physicians” (“Living Will”) allows you to make known your desires that artificial life- prolonging measures not be employed on your behalf.

RealTax professionals have the knowledge and expertise to help you make sure maximum wealth is passed to your heirs by exploring all estate planning opportunities, many of which are not discussed in this article. We specialize in real estate oriented accounting, tax planning, tax preparation and related services. We invite you to contact us with regard to your specific needs.