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How to Avoid Estate Taxes

If the value of your estate exceeds a federal maximum, your heirs could lose one-third to one-half of your assets to estate tax!

The Estate and Gift Tax System

Under current law, the estate tax and gift tax systems are still unified, so the rate of tax is the same whether an asset is given away during life (as a gift) or after death (as part of an estate). A tax problem may arise, however, when you have more than a federally determined maximum in assets. Each dollar over the maximum will be taxed as it is given away, at a rate of forty-five percent.

Annual Exclusion Gifts

Every year you may give away a certain amount of money or equivalent property to as many people as you wish, without the gift counting toward the maximum exemption. For example, if you have an estate worth $1,000,000, you may decide to give $15,000 per year to each of your four grandchildren, thus reducing your estate by $60,000 each year. This type of estate planning tool is appropriate for those who feel they can remove the money from their estate and still live comfortably.

Living Trust (Revocable)

A living trust for a married couple can be drafted to shield up to twice the federal maximum from estate tax. If you are in an unmarried partnership, you must make special provisions in your will or trust in order to avoid disinheriting your partner or subjecting your partner to tax liabilities.

A revocable living trust is the most commonly used estate planning tool for couples whose total assets are worth up to twice the federal maximum. It is easy to understand, easy to put into place, and easy to administer during your lifetime. The surviving partner will be well provided for, and the estate tax benefits are clear and predictable.

What Should I do?

Of course, you should consult your estate planning attorney, but generally most people will benefit greatly from a Revocable Living Trust, because that planning tool is designed to achieve two goals: avoid probate and save on estate tax. The new tax law does not address probate procedures or expenses, so the goal of avoiding probate through use of a revocable living trust remains significant.

Irrevocable trusts are still being used for several reasons. Some estate planning attorneys believe it is important to remove assets from one's estate now, thereby keeping the taxable portion of the estate as low as possible. If an asset is removed from your estate now, then any future growth in the asset occurs outside of your estate and thus, the growth will not be subject to estate tax. Certain irrevocable trusts, as discussed below, will yield impressive savings in estate tax. There are also nontax reasons: sometimes an irrevocable trust is preferred over an outright gift, because keeping the asset in trust can prevent squandering by the beneficiary or loss of the funds in event of a divorce. Another use for an irrevocable trust is to provide income for a disabled child.

Personal Residence Trust (Irrevocable)

This type of trust is an excellent estate planning tool for larger estates, especially those that include a house that has appreciated significantly in value. As owner of the residence, you place your house into the personal residence trust during your lifetime, but your beneficiaries must wait a certain number of years before they will receive the house.

Through the personal residence trust, you remove a substantial asset (your house) from your estate, but will be assessed gift tax on only a portion of the value of the asset, securing a savings of many thousands of dollars. (It is not uncommon to save $50,000 to $100,000 in taxes through the use of a personal residence trust.)

Grantor Retained Annuity Trust and Grantor Retained Unitrust (Irrevocable)

These trusts work on the same principle as the personal residence trust, except they are designed for assets other than a house. The GRAT and GRUT, as they are known, work very well for any asset that has appreciated or is appreciating in value. For example, as a shareholder, you could place your stock into a GRAT for a term of 10 years, with your children as the beneficiaries. The gift tax savings would be similar to those achieved through a personal residence trust (approximately twenty to thirty percent of the value of the asset, depending on the length of the term of the trust).

Under the GRAT, you would receive an income of a fixed dollar amount each year. Had you set up a GRUT, you would receive a percentage of the value of trust assets each year. After 10 years, all the stock would pass outright to your children.

Charitable Remainder Trust (Irrevocable)

A charitable remainder trust is useful for an appreciated asset that is not producing much income. For example, you have a vacation home that you never use because it is too far away and too much work. You decide to give the property to your favorite charity using a charitable remainder trust. Since charities do not have to pay capital gains tax, the charity sells the vacation home for its current fair market value, say $500,000, and invests the entire proceeds, according to the provisions of the trust. You would receive a fixed dollar amount every year, at a rate of five percent or more of the value of the trust. At five percent, that would be $25,000 per year for the rest of your life. Assuming the principal is invested well and yields an annual return of at least five percent, when you die the original principal of $500,000 will remain, and will be owned by the charity. You have made an important gift to charity, have established a guaranteed income for yourself for the rest of your life, and have arranged for a substantial deduction on the amount of estate tax due from your estate when you die.

There are many ways to avoid paying estate tax, all of which are legal and above-board. A combined estate worth up to twice the federal maximum need not pay any estate tax if the proper planning is done. Estates worth more than the maximum will be assisted by the variety of irrevocable trusts available and could also end up legally paying no estate tax. There are other options in addition to those discussed here, as well as combinations of trusts that can be arranged to make an estate plan that is perfect for each situation.

Attorney Deborah A. Malkin has practiced law in Santa Cruz, California since 1988. She specializes in wills, trusts, and other forms of estate planning, as well as probate matters. Deborah A. Malkin is a Certified Legal Specialist in Estate Planning, Trusts & Probate, certified by the Board of Legal Specialization of the State of California.

Deborah A. Malkin
Attorney at Law

2425 Porter Street, Suite 3
Soquel, CA 95073

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