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Estate Tax Strategies


Strategies for Reducing Estate Taxes
The key to keeping your estate intact for your beneficiaries is to reduce your estate tax liability through estate planning. There are many strategies available, and what is right for your unique situation depends largely on your total net worth and how you want to distribute your assets. This page provides an overview of some of the most common tactics used to reduce your estate's tax liability. These approaches fall into four categories: a gift-giving program while you are alive, the use of both lifetime exemptions if you are married, the removal of assets from your estate by setting up trusts, and the use of life insurance to pay part of your estate tax liability.
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Use Your Annual Gift Exclusions
The least complicated way to pass assets on to your beneficiaries is to use the annual gift exclusion and give them each annual gifts of up to $13,000 (or $26,000 from a couple) while you are alive. For instance, you and your spouse could give your two married children, their spouses, and your three unmarried grandchildren a cumulative total of $182,000 each year. When such gifts are given annually to several recipients, the annual gift exclusion can be an effective way to reduce the value of your estate and thus its estate tax liability. Additionally, you get to see your loved ones enjoy and use your gifts. To qualify for the annual exclusion, a recipient must have a "present interest" in the gift, which means that the recipient must legally be able to use the gift immediately.

If you want to use the annual gift exclusion but do not want to give control of the gifted assets to younger recipients, you can put the gift into a Crummey Trust. This is a special type of trust that allows donors to meet the present-interest requirement and take advantage of the federal annual gift exclusion even though a transfer to a trust is usually considered transfer of a future interest. A Crummey Trust satisfies the present-interest requirement by providing a 30-day window during which beneficiaries have the legal right to withdraw all or a portion of the gifted assets. If a contribution is not withdrawn, the trust's terms specify when and how the assets can be used after that window expires.

Use Both Lifetime Exemptions
Many married couples assume that estate planning is unnecessary because the unlimited marital deduction allows the surviving spouse to receive all of the couple's assets without paying estate taxes. The result is that the lifetime exemption ($1.1 million as of 2010) of the first spouse to die is often unused. When the surviving spouse dies, the estate pays taxes on the full amount, which could be as high as 55%. To prevent this and take advantage of both exemptions, you can create a Family Trust, which is also called a Credit Shelter Trust, a Bypass Trust, or an Exemption Trust. At the first death, the estate can be split into a Family Trust for an amount up to the value of the lifetime exemption and these assets can be kept outside of the surviving spouse's taxable estate, even though the survivor has the lifetime use of those assets. When the first spouse dies, the trust uses the first exemption; the second exemption is used upon the death of the surviving spouse for the assets remaining in his or her estate. This type of trust is the most common way for families to reduce estate taxes.

Remove Assets from Your Estate
The most effective way to reduce the taxes to be paid by your estate is to make your estate smaller. Some ways to accomplish this are:

Family Limited Partnership (FLP): An FLP is a business organization owned by family members, usually with the parents as general partners with full control and risk, and the children as limited partners with no control and limited risk. The general partners control the FLP's assets--which might include a family-owned business, real estate, or stocks--including distribution and investment decisions. Partners are entitled to income from the partnership in porportion to their ownership interest. By giving the shares of limited partnership to your children, you can remove up to 99% of the asset's value from your estate. Additionally, the limited partnership shares' value is highly discounted because there is no market for them, so general partners can transfer limited shares to family members at a reduced gift-tax cost. The FLP must be conducted like a business in order to withstand the formalities of an IRS audit or legal challenge verifying that the assets within the partnership are indeed business related. FLPs should also be funded for likely debts of the partnership. Personal assets shouldn't be placed in the partnership.

Grantor Retained Annuity Trust (GRAT): GRATs are irrevocable trusts that let you transfer income-producing or highly appreciating assets to the trust, yet enjoy an annuity from the assets for the fixed term of the trust. At least once a year, you, as the grantor, receive a fixed dollar amount. After the trust ends, any assets remaining in the trust after payment of your annuity go to the beneficiary. The gift tax is paid based on the asset's original value reduced by the present value of your retained annuity and can be substantially less than corresponding estate taxes, if the asset appreciates significantly.

Charitable Remainder Trust (CRT): A CRT allows you to act on your charitable intentions while reducing your estate taxes. This reduces your estate taxes by removing a highly appreciated asset, such as stock or real estate, from your estate. With this type of trust, you as the grantor make a charitable gift of a highly appreciated asset to the CRT's trustee (who can be you), and the trustee sells the asset (without paying capital gains taxes because the trust is a charitable entity) and reinvests the proceeds. Funds in the CRT are split between an income beneficiary (typically you) and the remainder beneficiary (your favorite charity or family foundation). At least once each year for the term of the trust you receive a fixed dollar amount or a fixed percentage of the asset's value, revalued each year. After the term expires, the balance goes to the charity. Because you are able to sell an appreciated asset inside the CRT without paying capital gains taxes, you are able to enjoy a higher income stream for life from the earnings of the CRT assets, which are undiminished by income taxes while invested inside the trust.

Charitable Lead Trust (CLT): A CLT is functionally the opposite of a CRT. In a CLT, the charity receives the income from the trust and the remainder reverts back to the donor's family (usually children) after the trust ends. As with a CRT, a CLT reduces the size of your estate. The value of your gift to your children is discounted because the total value of the property contributed to the CLT is reduced by present value of the income stream to be paid to the charity. If you have an asset that you think will appreciate at a rate in excess of the IRS's conservative rate assumptions, the excess appreciation may be transferable to your beneficiaries with little or no gift tax cost. A CLT is appropriate if you are very charitably motivated.

Dynasty Trust:A Dynasty Trust uses the $2,000,000 (indexed for inflation) per donor exemption or $4,000,000 per a couple to transfer assets in trust for future generations, typically your grandchildren or great-grandchildren. This is a complex planning tool intended to protect as much as you can for as long as you can. By skipping one or more generations, your family can avoid the estate tax burden that would otherwise be levied at each generation. A Dynasty Trust can provide for your children (although it need not, if they are well off), but it is structured in a way that your children benefit from the assets without having the assets included in your children's estates.

Qualified Personal Residence Trust (QPRT): The QPRT removes your home from your estate at a discounted value. With a QPRT, your residence is transferred into a trust for the ultimate benefit of your beneficiaries (usually your children) after a specified time. Prior to the end of the trust term, you can continue living in your home. When the trust ends, the house becomes the property of the beneficiary, and you must either move or pay rent to continue living there. The QPRT is most appropriate if your net worth is between $2 million and $10 million and your house accounts for a substantial portion of your assets. Because using a QPRT involves giving up your home, this type of trust works best for a vacation home.
Use Life Insurance to Pay Estate Taxes
Unlike a traditional insurance policy that is part of your estate, you can set up an Irrevocable Life Insurance Trust (ILIT) as an entity separate from your estate. The benefits paid to the trust are not subject to estate taxes and can be earmarked to pay all or part of the estate's tax liability following your death. The result is that your estate does not have to produce the cash to pay the estate taxes.

To set up an ILIT, you have two choices: transfer an existing life insurance policy to an ILIT, or purchase a new policy through an ILIT. Transferring an existing policy removes that asset from your estate, but the process of changing the policy ownership to the trust can involve many complexities. Also, there is a tax rule that includes the proceeds of any life insurance policy transferred by the insured within three years of death in the insured's estate. For this reason, an ILIT is best funded with cash, and the trustee then acquires a new policy for the benefit of the trust. Married couples can consider buying a survivorship life, or second-to-die, insurance policy, which insures both spouses but pays benefits only when the second spouse dies, which is when the insurance benefits will be needed to pay estate taxes. Typically this type of insurance is less expensive than insuring either spouse individually.

Using Strategy to Design Your Estate Plan
A comprehensive estate plan is likely to include a combination of several strategies like those introduced in this article. Each has its advantages and disadvantages and should be selected to suit your specific assets and goals. Talk to an estate planning professional about your unique situation before making any decisions about which strategies you want to use to reduce your estate tax liability.

Shoreline's Competitive Edge
Whatever your estate planning need, Shoreline Wealth and Investment Management can assist you in obtaining the best in tax planning advice.

For more information:
If you'd like more information about how diversified investment advisors can help you achieve your financial objectives through personalized wealth or retirement and risk management strategies, please contact us. We welcome the opportunity to discuss your unique needs and how we may best meet them.

This page (formatted for versions 10.0 and higher of Internet Explorer) is updated regularly so check in from time-to-time to see new articles and updates. You can click on any underlined words on each page to see a specific wealth management topic in the left margin of each page.

Charles M. Bloom, Registered Principal offers securities and advisory services through Centaurus Financial, Inc. - Member FINRA and SIPC - 775 Avenida Pequena, CA, 93111 (mailing address: 3905 State Street Suite 7173, Santa Barbara, CA, 93105) - CA Life Insurance License No. 0A52786 - Centaurus Financial, Inc. and Shoreline Wealth & Investment Management are not affiliated companies.

The information contained in this web site is neither an offer nor solicitation of any security or service.


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