Estate Tax Planning
Numerous tools and techniques can be utilized to reduce or eliminate federal gift and estate taxes. By creating different types of trusts, business entities, and utilizing advanced planning strategies, a client can effectively maintain control of the estate during their lifetime and effectively transfer wealth to others with minimizing their gift and estate tax liability. In addition, clients can also reduce income tax and capital gains taxes on certain transactions by utilizing these types of tools and techniques.
Irrevocable Life Insurance Trusts
An irrevocable life insurance trust effectively allows a client to pre-pay some or all of an estate tax bill for pennies on the dollar. A life insurance policy is held by an irrevocable trust that will distribute proceeds to beneficiaries that may be used to offset any estate tax liability. Premium payments for the life insurance policy can qualify for the annual exclusion for gift taxes if beneficiaries are given a right to demand immediate use of the funds. The trust terms will establish a method for administering this demand right. Because premium payments qualify for the annual exclusion, proceeds from the insurance policy after death are not taxable as part of the gross estate. This tool is very common in estate planning because of its relative simplicity and versatility.
Charitable trusts are established to receive many tax benefits. Generally, clients can gift appreciated assets into an irrevocable trust. The asset is then sold at fair market value by the trustee and the proceeds of the sale remain in the trust to be invested. The clients are entitled to an income stream for life and their chosen charity will receive the balance of the principal after their death. This is advantageous to the client because the asset was sold in a capital gains tax free environment, the client can take a current income tax deduction for the present value of the estimated gift to the charity, and the asset is removed from the gross estate of the client reducing federal estate tax consequences. This tool is often used in conjunction with an irrevocable life insurance trust established to replace the value of the assets that would be given to a charity instead of a family beneficiary. This strategy makes sense in most situations because the cost of premiums is outweighed by the tax savings to the client.
Family Limited Partnerships
A family limited partnership is a gifting strategy using a limited partnership business entity to accelerate gifting beyond the annual exclusion for gift taxes. A limited partnership is created with the clients as general partners. The limited partnership agreement stipulates restrictions on distributions and transfer of ownership. Over time the client will gift small percentages of the limited partnership to children as limited partnership shares. These shares will be transferred subject to certain discounts allowed for by the IRS. These discounts include a lack of marketability discount and a minority interest discount. Because gifted shares are devalued by these discounts, clients are allowed to make larger transfers then would be allowed had the asset not been held by the limited partnership. Over time the client will own only a small percentage of the limited partnership and the children will own most of it. This will result in a smaller gross estate for the client’s estate tax calculations after death. One major advantage is that the client will maintain control of the assets during lifetime as general partner.