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Estate
Planning is management of you assets during and after your lifetime for the
benefit of your self and your family. It's having concern about the tax
implications, it's having concerns about lifetime gifts to children, it's
having concerns about your pension benefits and how they should be handled,
family business and what is going to happen to it, and many other factors.
Determine the Planning Objectives.
While specific planning objectives will vary from one client to another, the
general objectives of the planner and the client are to design an estate plan
that features the following six factors: 1.
Control 2.
Management 3.
Tax & Saving 4.
Flexibility 5.
Asset Protection 6.
Leveraging the available tax – Planning
opportunities 7.
Federal Estate and Gift Taxes –
Imposition and Unified Tax Rates Federal Estate
and Gift Taxes ‑ Imposition and Unified Tax Rates. The federal government imposes a tax on the transfer of assets wherever located by a person who is a United States citizen or resident. The tax is applicable to transfers made during a person's lifetime (the gift tax) and to transfers made or taking effect at death (the estate tax). Transfers are taxed *in accordance with a Unified Tax Rate Table, as set forth below. All property
owned at death is subject to the estate tax. The gift tax applies to any
direct or indirect lifetime transfer of property, including outright gifts or
gifts in trust. 2000
UNIFIED TAX RATE TABLE
The Applicable
Exclusion and the Unified Credit. The Unified
Credit refers to a credit that is permitted to be claimed against the
tentative tax being imposed on transfers made during life or at death shown in
the chart above. The effect of the Unified Credit is therefore to reduce the
amount of tax which may actually be due. Application of the Unified Credit
results in the exclusion of an amount of assets from taxation. Applicable
Exclusion Amounts and the corresponding amounts of the Unified Credit. THE
UNIFIED CREDIT - APPLICABLE EXCLUSION AMOUNTS
Estate
and Gift Taxes are Unified and Cumulative The federal estate and gift taxes are based on a single tax rate table under which all lifetime taxable transfers and all taxable transfers at death are considered together and taxed at marginal rates starting at 37 percent and ranging up to 55 percent. In addition, a 5% surtax applies to transfers in excess of $10,000,000 up to $17,184,000. For transfers
made during lifetime, an individual must consider previous taxable gifts (made
after 1976) in calculating the transfer tax due. For example,
assume an individual who had previously made no taxable gifts makes a
$1,250,000 taxable gift in a year when the amount of the applicable exclusion
is $1,000,000. The gift tax due would be $102,500 ($448,300 tentative tax less
the unified credit of $345,800). If the individual
made an additional taxable gift the next year in the amount of $250,000, the
gift tax due would be $107,500. (Cumulative gifts of $1,500,000, tentative tax
of $555,800, less unified credit of $345,800, less $102,500 previous tax
paid). If the individual
later died having made no further taxable gifts, and had assets valued at
$3,500,000 at the time of death, the tax due from his estate at death would be
$1,835,000 ($3,500,000 owned at death, plus $1,500,000 adjusted taxable The Marital
Deduction. An unlimited
marital deduction is provided for transfers between spouses during lifetime
(Code Section 2523) and at death (Code Section 2056). Transfers to a
spouse who is not a United States citizen are not eligible for the unlimited
marital deduction (Code Sections 2523(i) and 2056(d)). Special limitations
apply to transfers to spouses who are not United States citizens (See the
discussion below). For the marital
deduction to be available, property must "pass" to the surviving
spouse in a qualifying manner. There are three primary methods by which
property can pass to a surviving spouse and qualify for the unlimited marital
deduction. These include:
a. The property may pass outright to the surviving spouse, either ‑under
a will or trust, by the laws of intestacy, pursuant to a life insurance
contract, through a designation under a retirement plan, or by operation of
law to a surviving joint tenant.
b. The property may pass to a qualifying general power of appointment trust.
Such a trust must provide for income to be payable to the beneficiary spouse
at least annually for life, and such spouse must also be given a general power
to appoint the property to whomever such spouse desires, including oneself,
one's estate, one's creditors and the creditors of one's estate. The power of
appointment trust may, but need not, permit discretionary distributions of
trust principal to the spouse by the trustee. Code Section 2056(b)(5).
c. The property may pass to a qualified terminable interest trust (often
referred to as a QTIP trust). In order for a trust to qualify as a proper QTIP
transfer, all of the trust income must be payable at least annually to the
spouse, the spouse may be given an interest in the trust principal There are two
other less commonly used methods to qualify for the marital deduction.
d. The estate trust is a trust in which the surviving spouse and the spouse's
estate are the only beneficiaries. Trust income may be accumulated, rather
than paid to the surviving spouse. (Revenue Ruling 68-554). With the
compression of income tax brackets and the imposition of the highest income
tax rates on estates and trusts by the Revenue Reconciliation Act of 1993,
this technique has fallen from favor and is rarely used any more.
e. The surviving spouse's interest in a charitable remainder trust will
qualify for the marital deduction if the spouse is the only noncharitable
beneficiary of the trust. Code Section 2056(b)(8). The Gift
Tax Annual Exclusion. Every person is
entitled to an exclusion from gift taxation for gifts of up to $10,000 per
year to each donee. This amount is not cumulative - it exists on a "use
it or lose it" basis. The $10,000 annual limit is indexed for inflation. In order to
qualify for the annual exclusion, gifts must be of a "present
interest", as distinguished from gifts of a future interest, for which
the annual exclusion is not available. Accordingly, absent special provisions,
gifts made in trust where the enjoyment of the transferred property is not
immediate will not qualify for the present interest gift tax exclusion, and
such gifts will either be required to absorb Education and
Medical Payments. The federal gift
tax also includes an express exclusion for transfers in any amount made on
behalf of an individual directly to an educational institution as tuition, or
to a medical care provider for the payment of medical expenses. Code Section
2503(e). Reimbursement payments for such expenses made to the donee will not
qualify for this exclusion. A transfer in trust with the income to be used to
pay the tuition or medical expenses of an individual will not qualify for this
exclusion. The limitation of this exclusion to tuition does not cover room and
board, books, or other similar expenses. There is no requirement that the
donee be a dependent of the donor, or for that matter in any way related to
the donor to qualify for this exclusion. Gift-Splitting When one spouse
makes a gift to a third person, the gift may be treated as made one-half by
each spouse, provided that the other spouse consents to the gift. This is
referred to as "gift‑splitting" by the spouses, and enables
them to effectively double the annual gift tax exclusion available for each
donee from $10,000 to $20,000. Code Section 2513. If each spouse
has $10,000 available for gifting to a particular donee, gift splitting is not
required. The filing of a federal gift tax return (Form 709) is necessary when
spouses split their gifts. There is a place on the return to indicate a
spouse's consent to gift giving by the other spouse. The consent must relate
to all gifts made by both spouses during the year. No gift tax return is
required when a person's own transfers fall within the $10,000 annual
exclusion. Planners should always check to see if the state in which the
client resides has its own gift tax laws. Some, but not all states do have a
gift tax statute. Gift-splitting is available exclusively to
spouses. Splitting a gift with a person Special
Marital Deduction Rules for Non-Citizen Spouses. Transfers made to
a spouse who is not a United States citizen will not qualify, as a general
rule, for the marital deduction. This rule applies regardless of whether the
donor spouse is or is not a United States citizen. With respect to
lifetime gifts to a spouse who is not a United States citizen, the unlimited
gift tax marital deduction of Code Section 2523 does not apply. Instead,
transfers to a non-citizen spouse of up to $103,000 per year (originally
$100,000 per year, this exemption is now adjusted annually for inflation) will
qualify for the gift tax annual exclusion, so long as the gifts are of present
interests. Code Section 2503(b). All other transfers in excess of this annual
gift allowance for a non‑citizen spouse will be fully taxable gifts.
Code Section 2523(i). Property passing
to a surviving spouse at death who is not a United States citizen will not
qualify for the estate tax marital deduction unless the property passes into a
qualified domestic trust (QDOT). Code Sections 2056(d) and 2056A. A number of
technical requirements apply here, including the requirements that such a
trust be constituted in a manner similar to a QTIP trust, discussed above;
that the trust have at least one trustee who is a United States citizen or a
domestic corporation, which trustee has the right to withhold from any
distribution to the surviving spouse the estate tax imposed on the
distribution; that if the trust assets exceed $2,000,000 at the deceased
spouse's death, the trust must provide that either at least one trustee is a
United States bank or trust company, or that the trustee furnish a bond equal
to 65% of the value of the trust assets as of the deceased spouse's death. Not
more than 35% of the trust assets, valued annually, may be invested in real
estate located outside of the United States. Reg. 20.2056A-2(d). The proper use of
a QDOT, and the making of all the necessary QDOT related elections, allows a
marital deduction to be claimed at the death of the first spouse and a
deferral of federal estate tax on the decedent spouse's property until the
death of the non‑United States citizen surviving spouse, or other
taxable distribution eve nt. Tax Inclusive
vs. Tax Exclusive Aspects of Lifetime and Death Transfers. Although the same
tax rates apply to transfers subject to the gift tax and to the estate tax,,
the method of calculating the two taxes is substantially different. This
difference results in the effective tax rate applicable to transfers at death
being more than twice as high as the effective tax rate applicable to lifetime
gifts. The reason for
this significant difference in effective rates is the fact that the estate tax
is "tax inclusive" (that is, the entire estate owned at death is
taxed, including the funds that are used to pay the estate tax) while the gift
tax is "tax exclusive" (that is, only the actual gift itself is
taxed). The net result is that substantially more valuable property can be
transferred by making lifetime gifts, rather than by awaiting a decedent's
death. To illustrate
this point, consider this Example: Assume a Taxpayer
(T) has used up all of his unified credit, has $2 million of assets remaining,
and the transfer tax rate is 50%.
Alternative 1: T
makes a $1 million lifetime gift to daughter (D). D receives $1 million, there
is $500,000 of transfer tax due from T, which T pays, and T still has $500,000
left.
Alternative 2: T
makes no lifetime gift, and dies with the $2 million. His will leaves his
property to D. T's estate tax liability is $1 million, leaving $1 million for
D. In Alternative 1,
D got $1 million, the taxes were paid, and $500,000 remained available to T
possibly for further gifting to D. In Alternative 2,
D got $ 1 million, the taxes were paid, and nothing was left. Even if we
assume that the $500,000 remaining available in Alternative I will be taxed at
T's death (not a necessary assumption given annual gift tax exclusions and
other tax‑free transfer opportunities) D will receive $250,000 of that
property and at the very least be better off by that amount when Alternatives
I and 2 are compared. The tax exclusive
calculation used for gift transfers will always be more favorable than the tax
inclusive estate tax calculation, except if a donor dies within three years of
the date of the gift, since the gift tax paid within three years of death is
included in the estate as an includable transfer made within three years of
death. Transfers
Made Within Three Years of Death. As a general
rule, gifts made within three years of death (so-called "gifts in There are several
situations, however, where transfers made within three years of death are
brought into the estate at their date of death value. Where these rules apply,
the motive of the transferor is irrelevant. The three year rule is applied
mechanically. The most notable
exception to the general rule here involves the transfer of life insurance
policies on a decedent's life. Such a transfer within three years of the
decedent's death results in the full amount of the policy proceeds being
included in the decedent's estate. Code Section 2035. As indicated in the
previous section, payments of gift tax within three years of death are brought
back into a decedent's date of death calculations. Where a decedent has
transferred property while retaining some rights to control or enjoy the
transferred property and then releases those retained rights or interests
within three years of death, the value of the retained interests is included
in the decedent's taxable estate. Income Tax
Basis Rules - Lifetime Gifts. When a donor
makes a gift during lifetime to a donee, the donee takes an income tax basis
in the gifted property equal to the donor's basis in that property, increased
by the amount of any gift tax that was actually paid. This is called a
"carryover basis" Code Section 1015. Income Tax
Basis Rules - Property Received from a Decedent. When a person
receives property from a decedent, the recipient's basis in the property
received is equal to the fair market value of the property as reported by the
decedent's estate (either the date of death value of such property, or the
alternate valuation date value, if the alternate date is properly elected on
the decedent's federal estate tax return (Form 706)). This is called a
"stepped-up" or "stepped-down" basis. Code Section 1014.
Where this rule applies, the decedent's own cost basis in the property becomes
irrelevant. No stepped-up
basis is available for property which was transferred to the decedent within
one year of the decedent's death and returned to the transferor as the result
of the decedent's death. Code Section 1014(e). No stepped-up
basis is available for items which are classified as items of "income in
respect of a decedent" (see the discussion below). Income in
Respect of a Decedent. Income in respect
of a decedent (IRD) refers to those items of income that a decedent earned,
but did not receive prior to his or her death. Examples include accumulated
retirement plan benefits, IRAs, accrued salary, balances due of installment
payments, and certain interest and dividend payments. Since a decedent had a
claim of right to these items at the time of death, IRD items are included in
the decedent's estate at their present value at the time of the decedent's
death. IRD items do not
receive a stepped-up basis, despite their inclusion in a decedent's estate.
However, the beneficiary of an IRD item is allowed to claim an income tax
deduction for any estate tax paid on. such item by the decedent's estate. Taxation of
Jointly-Held Property. The value of a
decedent's interest in jointly-held property or property held as a tenant by
the entirety is taxable at the decedent's death. Where the joint
owners of the property are husband and wife, one-half of the value of the
jointly held property is included in the estate of the first joint tenant to
die, regardless of which of them actually furnished the consideration. Code
Section 2040(b). Where the joint
owners of the property are other than husband and wife, there is a rebuttable
presumption that the entire value of the joint property is included in the
estate of the first joint tenant to die, subject to the ability of the
surviving joint tenant to prove his or her contribution to the cost of the
property. Code Section 2040(a). Since only one-half
of the value of jointly held property is included in the estate of a decedent
spouse, the surviving spouse receives a stepped-up basis in only one-half of
such property. Taxation of
Powers of Appointment. The value of
property subject to a general power of appointment is taxable in the estate of
the holder of the power. If the power was created on or before October 21,
1942, it must be exercised by the decedent to be included in the decedent's
estate. If the power was created after October 21, 1942, it need only be
possessed by the decedent at death, or exercised or released in a testamentary
manner to require the property subject to the power to be included in the
decedent's estate. Code Section 2041 (a). The term
"general power of appointment" refers to a power which is
exercisable in favor of the decedent, his estate, his creditors and the
creditors of his estate. Code Section 2041 (b)(1). This may be contrasted with
a "limited" or "special" power of appointment which may be
exercised in favor of any one else without being included in the decedent's
estate. A power to
consume, invade or appropriate property for the benefit of a decedent which is
limited by an "ascertainable standard" relating to the health,
education, support, or maintenance of the decedent is not deemed to be a
general power of appointment. Code Section 204 1 (b)(1)(A). The technique of
limiting a transfer by an ascertainable standard is often used in estate
planning documents to Taxation
of Life Insurance Proceeds The proceeds of a
policy of life insurance that insures the decedent's life is included in the
decedent's estate in two circumstances.
a. The policy is payable to the decedent's estate, or otherwise to the
decedent's executor for use in connection with the decedent's estate. Code
Section 2042(a).
b. The decedent retained an "incident of ownership" in the life
insurance policy, i.e. a right to designate a beneficiary, borrow against the
cash value of the policy, pledge the policy as collateral for a loan, etc.
Code Section 2042(b). The transfer of
ownership of a life insurance policy to another person, or to an irrevocable
trust in which the transferor‑decedent held no incidents of ownership
removes the life insurance proceeds from a decedent's estate, even if the
decedent continued to pay the life insurance premiums prior to death;
provided, however, that such a transfer was made at least three years prior to
the death of the decedent. (See the discussion in "Transfers Made w/in 3
yrs.", above). If a life
insurance policy is taken out on the life of the decedent by another party,
including the trustee of an irrevocable trust, and if the decedent never
possessed any incident of ownership in the policy, the proceeds of the policy
are excluded from the decedent's estate even if the decedent dies within three
years of the inception of the policy. As a general
rule, death benefits under a life insurance policy are received free of
federal income tax. Code Section 101. However, there is an important exception
to this rule known as the "transfer for value" rule. If a life
insurance policy is transferred for valuable consideration, the excess of the
amount of policy proceeds received by the new policy owner over the amount
paid to acquire the policy is taxable income to the new owner. Several important
exceptions apply to this rule. If a transfer is within one of the exceptions,
it is exempt from the transfer for value rule. The exempt transfers include:
transfers to the insured; to a partner of the insured; to a partnership in
which the insured is a partner; to a corporation in which the insured is a
stockholder or officer. Note that a transfer between stockholders is not an
exempt transfer. Accordingly, Us rule may be a problem in dealing with
transfers of life insurance policies which are held to Rind buy‑sell
agreements among corporate shareholders. Taxation of
Retirement Plan Benefits, IRAs and Annuities. As a general
rule, the value of all qualified retirement plan benefits, IRA accounts
(including traditional IRAs and Roth IRAs) and annuities in which a decedent
had an interest at death, and which are payable to a surviving beneficiary,
are included in the decedent's estate. Code Section 2039. In addition to
the federal estate tax consequences of these assets, they are (with the
important exception of the Roth IRA) also subject to income taxation in the
hands of the recipient, since they constitute income in respect of a decedent.
See paragraph 15, above. As such, they may also be eligible for a deduction on
the recipient's income tax return based on the estate tax paid as the result
of the inclusion of such items in the decedent's estate. It may be said
that these items, at the highest tax brackets (and ignoring the impact of
state death taxes and state income taxes) are taxable at the net tax rate of
approximately 73%. (Assume a 55% death tax rate and a 40% income tax rate
(95%) offset by an IRD income tax deduction of 40% of the 55% tax paid, or
22%, leading to the net effective tax rate of 73% (95% minus 22% equals 73%)). Community
Property. Community
property is property acquired by married individuals who reside in a community
property state. Each spouse is deemed to own an undivided one-half interest
'in the community property, regardless of who earned it or provided the
consideration for it. Where a spouse acquires property during the marriage by
gift or inheritance from a third party, such property is not deemed community
property. The income tax
basis rules applicable to community property acquired from a decedent are more
generous than the rules relating to jointly held property (See paragraph 16,
above). At the death of the first spouse to die, the income tax basis stepped-up
for both halves of community property. Accordingly, the surviving spouse
receives a new cost basis for his or her own half of the community property
(as well as for the half acquired from the decedent) when the other spouse
dies. Code Section 1014(b)(6). At the present
time, there are nine community property states, namely: Arizona, California,
Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin. There
are very substantial differences among these states with respect to the
technical aspects of each of their community property laws. Taxation of
Lifetime Transfers. Certain transfers
made by the decedent during lifetime are considered "testamentary"
in nature, and are brought back into the decedent's federal estate tax
calculation at their date of death (rather than date of transfer) values.
These transfers typically, but not necessarily, involve transfers to trusts.
The lifetime transfers subject to this rule include the following:
a. Certain transfers made by the decedent within three years of death. Code
Section 2035. See the discussion in paragraph 12, above.
b. Transfers made whereby the decedent retained the right to income from the
transferred property, or the right to possess or enjoy such property until the
time of the decedent's death. Code Section 2036.
c. Transfers made which take effect at the time of the donor's death in which
the donor retained a reversionary interest. Code Section 2037.
d. Transfers made whereby the donor retained the right to alter, amend, revoke
or terminate the transfer. Code Section 2038.
The Qualified
Family-Owned Business Interest Deduction. A decedent's
interest in a family-owned business may qualify for the Qualified Family-Owned
Business Interest Deduction (QFOBI) of $675,000 and an applicable exclusion
amount of $625,000, regardless of the year in which the decedent dies. If the
estate includes less than $675,000 of QFOBI's, the applicable exclusion amount
is increased on a dollar for dollar basis, but only up to the applicable
exclusion amount available for the year of death. Code Section 2057(a). Accordingly, the
maximum combined effect of the QFOBI deduction and the applicable exclusion is
$1.3 million in any given year. Since the applicable exclusion is being phased
in through 2006 (when it reaches $1 million) the use of the QFOBI deduction
has diminished utility in the coming years when considered in combination with
the applicable exclusion. While the QFOBI deduction will be fixed at $675,000,
the percentage of the applicable exclusion amount utilized by a decedent's
estate taking full advantage of the QFOBI deduction may actually decline. There are many
technical requirements to be satisfied to qualify for this deduction. The
major requirements include the following:
a. The business interest must be transferred at death by a decedent who was a
United States citizen or resident at death.
b. The value of the decedent's interest in the family‑owned business
must exceed 50% of the value of the decedent's adjusted gross estate (this
figure may be adjusted by including gifts made by the decedent to family
members other than the surviving spouse).
c. The business interest must pass to one or more "qualified heirs"
(i.e. family members of the decedent or an employee of the business for at
least ten years).
d. The decedent and/or family members must have "materially
participated" in the operation of the business for a period aggregating
five of the eight years prior to the decedent's death. In addition, the
qualified heirs and/or the qualified heir's family must own and manage The
Charitable Deduction. A decedent's
transfer tax liability may be reduced by making transfers to qualified
charitable organizations. The transfer tax deduction for charitable transfers
is unlimited. Code Sections 2055 and 2522. Gifts to charity
may be made as outright transfers. They may also take the form of a Charitable
Remainder Trust whereby a transfer is made to a trust that reserves a payout
(in the form of an annuity trust or a unitrust) to the trust grantor, the
grantor's spouse, or some other individual beneficiary for the lifetime of the
beneficiary or for a fixed term not in excess of twenty years. At the
expiration of the designated term, the trust property passes to one or more
charitable beneficiaries designated by the trust grantor or selected by the
trustees. A charitable deduction is available for the value of the property
transferred to the trust, less the actuarially calculated value of the
reserved payout interest. Charitable gifts
may also be made in the form of a charitable lead trust. In such a trust,
payments are made to one or more charitable beneficiaries for a designated
term of years, or for the life or lives of designated individuals, with the
trust property being distributed to one or more individuals (usually family
members of the trust grantor) after the expiration of the charitable term. If
created by the will of a decedent, such a trust generates an estate tax
deduction based on the value of the interest passing to charity, and enables
the balance of the trust property to pass to selected heirs in the future. The
Generation-Skipping Transfer Tax. The Generation-Skipping
Transfer tax ("GST tax') is imposed on all transfers made either during
lifetime or at death that are made either in trust or outright, to a person
two or more generations younger than the transferor. Such a person is referred
to as a "skip person". Code Sections 2601, 2611, 2613. The GST tax
is imposed at the highest rate of transfer tax, currently 55%, and is imposed
in addition to the regular gift tax or estate tax that may be due on a given
transfer of property. Code Section 2641. The GST tax is
imposed upon the occurrence of one of three possible generation-skipping
events.
a. Direct skip. This refers to a transfer subject to estate or gift tax
of an interest in property to a skip person or a transfer to a trust whose
only beneficiaries are skip persons. Code Section 2612(c). The GST tax is paid
by the transferor or the estate. The taxable amount does not include the
amount of the GST tax. Example: A
transfer of property directly from a grandparent to a grandchild or the
creation of an irrevocable trust by a grandparent solely for the benefit of
the grandchild.
b. Taxable Distribution. This refers to a distribution of income or
principal to a skip person from a trust which distribution is not otherwise
subject to estate or gift tax. Code Section 2612(b). Here, the GST tax is an
obligation of the transferee. If the GST tax is paid by the trust, the payment
is treated as an additional taxable distribution. Example: A
grantor establishes a trust permitting the " sprinkling" of income
and/or principal to a child and a grandchild. From the grantor's perspective,
the transfer to the trust is a potential gift tax event, depending on the
available of annual and lifetime applicable exclusions to the grantor.
Subsequently, the trustee makes a distribution of income to the grandchild.
Although this distribution is not subject to estate or gift tax, the
distribution is subject to the GST tax.
c. Taxable Termination. This refers to a termination of a beneficiary's
interest in a trust which results in all of the interests in the trust being
held by beneficiaries two or more generations younger than the transferor of
property to the trust. Code Section 2612(a). So long as one non-skip person
holds an interest in the property, a taxable termination cannot occur. Here,
the GST tax is paid by the trust. Example: A
trust is established by a grantor providing income for the life of a child
remainder to a grandchild. Upon the child's death, there is a taxable
termination if the grandchild is living and there are no other trust
beneficiaries with a present interest in the trust who belong to a generation
older than that of the grandchild. The Code provides
two areas of exemption from the GST tax.
a. Transfers exempt from gift tax under the $ 10,000 annual exclusion of Code
Section 2503 are also exempt from the GST tax. Code Section 2642(c)(1).
(i) Outright transfers under this exemption are
exempt from the GST tax.
(ii) Transfers to trusts must satisfy additional
requirements to qualify under this exemption. The trust must provide that
during the lifetime of its beneficiary, no part of the trust income or
principal may be distributed to or for the benefit of any person other than
the beneficiary, and if the beneficiary dies before the trust is terminated,
the trust assets must be includible in the beneficiary's estate. Code Section
2642(c)(2).
(iii) In addition, the GST tax does not apply to any
inter vivos transfer which would not be treated as a taxable gift ‑under
Code Section 2503(e), relating to payments of tuition or medical expenses.
Code Section 2611 (b).
b.
Every individual is allowed a GST tax exemption of $1 million (as
(i) The "inclusion ratio" of a trust is the
percentage of a trust that potentially is subject to GST tax, The ratio is
equal to the excess of I over the "Applicable Fraction". The
numerator of the fraction is the amount of the GST exemption being allocated
to a particular transfer. The denominator is the value of the property
transferred (less the sum of Federal or state death taxes recovered from the
trust attributable to such property (if any) plus any Federal gift or estate
tax charitable deduction allowed). Code Section 2642.
(ii) A trust with an inclusion ratio of zero is
completely exempt from GST tax.
(iii) A trust with an inclusion ratio of one is
completely subject to GST tax if a generation-skipping transfer occurs with
regard to the trust.
PART
TWO: THE TOOLS OF ESTATE PLANNING The Unified
Credit Shelter By-Pass Trust. As indicated in
"The Applicable Exclusion and Unified Credit" of Part One, every
person has available the unified credit against transfer tax. In 2000 and
2001, the unified credit of $220,550 shelters $675,000 of property from
transfer taxation. However, to benefit from this credit, it must actually be
used, and using it requires some affirmative planning. If all of a
decedent's property passes to a surviving spouse, there will not be any death
tax as the result of the unlimited marital deduction, but the opportunity to
use the unified credit at the first death of the spouses will be lost. The
credit will only be used at the second death, resulting in property valued at
$675,000 passing tax free to heirs - while that number could have been
$1,350,000 with better planning. For an individual
to fully utilize the unified credit, the individual must generally have
property equal to the annual exclusion amount (currently $675,000) titled in
his or her own name. Jointly-held property, as well as life insurance proceeds
and retirement plan benefits payable to a surviving spouse, pass directly to
such spouse, resulting in the unified credit not being used. A will leaving
everything to the surviving spouse has the same result. Properly
utilizing the unified credit requires a two-step process. First, title
property in the separate names of the spouses. If necessary, remove a
residence from joint ownership and place it in a tenancy in common (A good
feature of community property states is that the automatic division of
property into undivided equal shares for each spouse solves this problem).
Second, create an arrangement as part of the estate plan that deals with the
unified credit portion of the decedent's property. The plan most
commonly used is the unified credit shelter trust. At the decedent's death,
the assets are divided into two portions: (a) An amount equal to what can be
protected by the unified credit is used to fund a unified credit shelter
trust, and (b) The balance of the decedent's assets are used to fund the
marital deduction for the surviving spouse. The unified
credit shelter trust typically provided that all income from the trust will be
paid to the surviving spouse, along with such principal as the trustee may
determine, using discretion pursuant to an ascertainable standard. At the
surviving spouse's death, the trust property is typically paid to the children
of the couple. Thus the amount used to fund the credit shelter trust can
benefit the surviving spouse while living, but is not included in such
spouse's estate at death thereby bypassing the estate of the second
spouse to die. That spouse's estate uses his or her own unified credit at
death, resulting in the optimal use of the unified credit by each spouse over
two deaths. The
"typical" trust method of distribution is not the only possible plan
here. A "sprinkling" trust could be used, where the spouse along
with other beneficiaries could all be named as permissible beneficiaries, and
be paid the income and/or principal of the trust. Another alternative could
exclude the spouse as a beneficiary of a trust completely, and leave the trust
property available only for children or others. Still another variation would
be to leave the unified credit amount outright to beneficiaries other than the
spouse. The point is that using the unified credit at the first death, however
it is actually allocated, is a positive estate planning tool, allowing more
property to pass transfer tax free to one's ultimate heirs. The unified
credit may be used prior to one's death by making outright lifetime gifts to
non-spousal beneficiaries, or by setting up an inter vivos trust to benefit
the spouse as the (or a) life beneficiary as described above. An advantage of
this technique is that not only will the unified credit be used, but
post‑transfer appreciation on the gifted property will not be subject to
transfer tax when the donor dies. Retain Post-Death
Control Over Property with a Marital Deduction OTIP Trust. As indicated in
"The Marital Deduction" of Part One, there are several different
ways to leave assets to a surviving spouse that qualify for the marital
deduction. All of these techniques will obtain the desired tax result, namely
no tax on the property qualifying for the marital deduction at the death of
the first decedent, and deferral of transfer tax on such property until the
death of the second decedent. However, planning
sometimes reveals that one spouse has concerns about other's ability to manage
property, and may further be concerned that the survivor will leave the
property ultimately in a manner that the first spouse would not have desired
(such as disproportionately among children, to a new spouse or other third
party, etc). Of the available marital deduction techniques, the outright gift
assumes that the survivor is able to deal appropriately with both management
and control. I this is the case, then the outright gift is certainly the
simplest construction. If management is
a concern, but ultimate control is not, the general power o appointment trust
may serve the client's needs. The trust format will deal with th issues of
management of property, while giving the surviving spouse unlimited discretion
to leave the property as the survivor desires will place ultimate control in
the hands of the survivor. If both
management and control are concerns, the QTIP trust becomes the preferred
solution. While providing the lifetime benefit of all the trust income (and
possibly trust principal, if desired) for the surviving spouse, the trust
format deals with management issues, and the QTIP rules deal with control.
Under these rules, it is the will (or trust directions) of the first spouse to
die that controls the ultimate disposition of the trust property. Accordingly,
the surviving spouse, while entitled t the lifetime enjoyment of the property,
is not permitted to defeat the dispositive plan of the first decedent. Code
Section 2056(b)(7). Living Trusts. A living trust is
typically created as a lifetime transfer of property by the grantor to a
trustee (often the grantor acting as trustee, sometimes to the grantor and
another person acting as a co‑trustee, or to a third party acting as the
sole trustee). The primary beneficiary of the trust is the grantor. There may
or may not be other permissible beneficiaries while the grantor is living. The
grantor generally reserves the right to revoke the trust. Upon the grantor's
death, the trust becomes irrevocable, and typically contains the grantor's
entire estate plan, creating interests for spouse and children, incorporating
unified credit and marital deduction dispositions, etc. A living trust may be considered a
good idea in all cases where continuity of The greatest
limitation of the living trust is the careful attention that must be paid to
making certain that all of the decedent's assets are properly titled as owned
within the living trust. Any asset in the decedent's own name will be a
probate asset. Careful planning suggests having a will that "picks
up" any property that was not titled in the name of the living trust, and
"pours it over" into the trust. Bear in mind that the living trust is not a income tax-saving vehicle and sometimes does not save State estate taxes. All of the trust income is taxed to the trust grantor, just as it would be absent the living trust, and all of the trust assets are included in the taxable estate of the grantor at death - just as they would be if no trust had been created. Since the trust is revocable, the grantor does not make a gift when assets are transferred to the trust. Are
living trusts preferable to the probate of assets under court
supervision? It may be and it may not be. Consultation with your
attorney is necessary. Probate is often misunderstood and clients need
to know the costs and benefits and should ask about them. Courts are
often not as bad as many believe and avoiding probate does solve the concerns
of he trustee who has the duty to make distribution of the trust in some point
of time. If not done correctly - beneficiaries complain and litigation
results. Gift-Giving
and the Crummey Power As indicated
above in paragraph 7 of Part One, annual gifts of up to $10,000 per donee may
be excluded from transfer tax so long as the gift constitutes the transfer of
a present interest in property. However, when a gift is determined to be of a
future interest, the annual exclusion is not available, and the gift is
entirely taxable. To circumvent this problem in appropriate cases, the
technique of the Crummey power was developed, based on the case of Crummey
v. Commissioner, 397 F. 2d 82 (9th Cir. 1968); Rev. Rul. 73-405, 1973-2 CB
32 1. The Crummey power
refers to a currently available right of withdrawal that is included in a
trust. Permitting a trust beneficiary to exercise this right of withdrawal
creates the required present interest in the trust, permitting transfers to
the trust which are subject to this right of withdrawal to be qualified for
the present interest gift tax exclusion. The use of a Crummey power of
withdrawal is central to trust planning for minor beneficiaries and for
irrevocable life insurance trust planning, as discussed below. Gift Planning
for Children. Parents and
grandparents often desire to transfer property to their children and
grandchildren. Transfers of assets to minor beneficiaries utilizing either the
Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA)
are the simplest method to accomplish such gifts. These transfers qualify for
the present interest gift tax exclusion since the custodial property is vested
in the minor and must be distributed to the minor by age 21 (or by age 18 in
some jurisdictions). The UGMA/UTMA custodianship does contain certain
restrictions on the property that can be transferred into, or the investments
that may be held by such an arrangement. Greater investment and management
flexibility exists if a trust is used. One such
specially approved trust is the Code Section 2503(c) trust. This trust
provides that if all of its requirements are satisfied, transfers to it will
qualify for the present interest gift tax annual exclusion, notwithstanding
the fact that property is transferred to the trust and held in it until the
trust beneficiary attains age 21. The core requirements of this trust are: (a)
principal and income must be available for distribution to a single
beneficiary while the donee is under age 2 1; (b) if the donee survives to age
21, all accumulated income and principal must be distributed to the donee upon
attaining age 21, and (c) if the donee dies before age 21, all income and
principal must be paid either to the donee's estate or to the donee's
appointees pursuant to a general power of appointment. The most
significant drawback to the Section 2503(c) trust is the requirement that the
property must be distributed at age 21. The IRS has ruled that if the
beneficiary is given the right to withdraw the property from the trust upon
attaining age 21, and declines to do so, the property can remain in the trust
without forfeiting However,, since
there is always the chance that the beneficiary will decide to withdraw the
trust funds, the Section 2503(c) trust remains less than the ideal solution
for many prospective donors, particularly those that wish to make rather
significant gifts over a number of years. Here, the Crummey
Trust becomes a viable solution. The present interest in this trust exists by
virtue of the annual right of withdrawal, not a required distribution at any
particular age. A Crummey Trust could continue for the lifetime of a
beneficiary. So long as annual additions were not being withdrawn, such
additions would continue to be made. If the beneficiary exercised a right to
withdraw an annual gift against the wishes of the donor, further gifts could
be suspended. During the years that the beneficiary is a minor, the annual
Crummey notice of contribution and right of withdrawal would be given to his
or her guardians, presumably the parents of the donee. Where a
grandparent wishes to create a trust for a grandchild and make gifts to that
trust, the generation-skipping transfer tax rules for annual exclusion gifts
must be taken into account along with the gift tax annual exclusion rules. See
the discussion in paragraph 24 of Part One. For annual exclusion gifts in
trust to be exempt from the GST tax, the trust must be created for the benefit
of a single skip person and must be vested in that single beneficiary for
estate tax purposes. Code Section 2642(c)(2). Life
Insurance Planning Strategies. As indicated in
"Taxation of Life Insurance Proceeds" of Part One, the ownership of
a life insurance policy by an insured will cause the proceeds of that policy
to be included in the insured's estate. Accordingly, if husband owns a policy
on his life, names wife the beneficiary and dies, the proceeds are in the
husband's estate, but exempted from estate tax by the marital deduction. As a
result, when the wife dies, any remaining portion of the insurance proceeds is
part of the wife's estate. Having the wife own the policy does not solve this
problem, since the wife's receipt of the proceeds at the husband's death would
still result in the unexpended portion of the proceeds being This problem may
be solved by the use of an irrevocable life insurance trust (ILIT). Here, the
life insurance policy is owned by the trust, not by either of the spouses. The
insured may continue to pay the premiums on the policy, which premium payments
are deemed gifts of future interests to the trust beneficiaries. The Crummey
power should be used here to address and resolve this issue. Allowing the
trust beneficiaries to withdraw the annual additions to the trust per the
Crummey right of withdrawal creates the present interest in the trust, and
allows the premium payments by the trust grantor to be viewed as gifts of
present interests covered by the gift tax annual exclusion. The terms of the
ILIT typically provide that when the insured dies, the policy proceeds are
held by the trustee for the benefit of the surviving spouse, who is paid the
trust income and who may be given trust principal in the discretion of the
trustee pursuant to an ascertainable standard. The 'insured should not be a
trustee of this trust. When the
surviving spouse dies, the trust proceeds are paid to children or other
beneficiaries as determined by the dispositive provisions contained in die
trust as decreed by the originally insured spouse who created the trust.
Assuming there is no problem with the transfer within three years of death
rule, the ILIT as described herein results in the policy proceeds being
excluded from the insured's estate (at the time of death, the insured did not
possess any incidents of ownership in the policy or rights in the trust) and
also from the estate of the surviving spouse (who had only a life estate in
the trust, did not have a general power of appointment, and no marital
deduction election was required to exclude the property from estate taxation
at the death of the first spouse to die). The ILIT may be
used for whole life and term insurance, for policies that were owned by the
insured and transferred to the ILIT, or policies that were owned from
inception by the trustee of the ILIT It may be used for group policies where
the employer pays the premium. The ILIT may
provide an important source of liquidity when the surviving spouse dies. The
technique to employ here is to have the trustee of the ILIT use the life
insurance proceeds to purchase assets from the decedent's estate. This will
place cash into the estate for payment of taxes and other debts and will move
the family assets into die ILIT from which they can be distributed. This is a
far more Some taxpayers
have sufficient wealth so as to not require life insurance proceeds to support
or sustain a surviving spouse at the first spouse's death. However, such
taxpayers may still have a need for substantial liquidity at the second death,
if for no other reason than to pay the large death taxes that fall due at that
time. Here, a second to die life insurance policy may be acquired to only pay
off at the time of the second death. Such a policy should be held in an
irrevocable trust of which neither spouse acts as the trustee. At the second
death, the policy proceeds are collected and should pass free of any death tax
to the trust beneficiaries. Irrevocable
trusts holding second to die life insurance policies are sometimes combined in
an estate plan with significant gifts to charity. This arrangement is
sometimes referred to as a "Wealth Replacement Trust". Here, the
taxpayers leave a substantial portion of their estates (usually at the time of
the second death) to a charitable beneficiary (either outright, or to a
charitable remainder trust naming their children as the lifetime beneficiaries
of such trust or to a charitable lead trust, naming their children as
beneficiaries after the charitable interest expires). The effect of this
charitable gift is to dramatically reduce the amount of tax due from the
estate of the second spouse to die. However, since a substantial amount of
property is passing to charity, this gift also reduces the inheritance
available for children. To the extent that this causes the taxpayers concern,
they use the proceeds of the second to die policy passing free of transfer tax
to children as the means to "replace" the wealth that went to
charity and not to the family. Keep in mind that if such a policy is large,
the premiums will be costly, and there not may not be enough Crummey
beneficiaries to treat all premium payments as tax-exempt gifts, resulting in
taxable gifts that must be reported. Life insurance
also plays an important role in a number of other estate planning situations.
It provides the currency to enable a business buy‑out to be handled
smoothly. Funding an entity buy‑out or a cross purchase agreement among
business owners with life insurance policies relieves some of the strain on
business succession issues when one of the owners dies. Having life insurance
proceeds available at the death of a person who had significant interests in
IRA benefits Planning with
Disclaimers. Some people die
without having undertaken proper estate planning. Others are unable) despite
their best efforts, to organize the ownership of their assets to achieve the
optimal unified credit trust funding described in "The Unified Credit
Shelter By-Pass Trust" of Part Two. Others find that despite their best
efforts in planning, changed circumstances result in the plan not satisfying
all of the needs and issues at the time of someone's death. A possible
solution to all of these problems is the technique of the qualified
disclaimer. A qualified
disclaimer permits a donee to in effect turn his or her back on a purported
transfer of property, and instead allow it to pass to the next heir in the
line of succession. If all of the necessary requirements for a proper
disclaimer are observed, the disclaiming individual is never treated as having
owned the disclaimed property and is not deemed to have made a gift to the
ultimate recipient of the property. An important
consideration in deciding whether a disclaimer is appropriate is an analysis
of the disclaimer "path". That is, where will the property go if a
disclaimer is exercised. Without advance planning, a person may be faced with
the decision of whether to accept property knowing it will generate a high tax
liability, or disclaim it, knowing that it will pass outright to someone young
and irresponsible. Alternatively, if the possibility of a disclaimer in the
future is built into the estate plan when it is written, and a
"disclaimer path" created that is sensible (such as having
disclaimed property pass to a discretionary trust for the benefit of children
which refrains from required outright distributions until an age of (supposed)
maturity is reached) then the disclaimer alternative may be viewed more
favorably. In order to have
a "qualified" disclaimer, it must be in writing and effected within
nine months after the later of the creation of the interest to be disclaimed
or A disclaimer may be used to create a unified credit transfer when "too much" property passes outright to a surviving spouse, or protect an estate from taxation when the value of property passing to non-spousal beneficiaries exceeds the amount of the applicable exclusion, and the disclaimer results in the increase of the marital deduction. Disclaimers can be made of fractional interests in property or 'in specific items of property. A joint tenant in property may disclaim his or her survivorship interest in the joint property within nine months of the death of the deceased joint tenant. Reg. 25.2518-2(c)(3)-(5). Valuation
Discounts. Recognizing and
using valuation discounts is a key element in effective estate planning. Where
family businesses and other closely-held business and investment enterprises
are involved, valuation discounts are used to reduce the cost of transferring
these assets. Valuation begins
with the general proposition that assets are to be valued at their "fair
market value", typically a willing buyer/willing seller analysis. Reg.
20.203 1 - I (b). But it becomes quickly evident that aside from securities
regularly traded on an established stock exchange, many assets are not easily
valued (See the valuation criteria contained in Rev. Rul. 59-60, 1959-1, CB
237), thus opening the door for a valuation discount analysis. Among the most
important valuation discounts are those available for: a) minority interest,
addressing the issue of lack of control over the business enterprise; b) lack
of marketability, reflecting the fact that there is no ready market for shares
'in the business; c) key person, referring to the possible loss of a key
element in the success of the enterprise; and d) built‑in capital gains
discount, recognizing the The Internal Revenue Service has acknowledged that in determining the value of shares in a family-held business, family control would be disregarded, and each piece of the business interest would be viewed separately and distinctly, allowing a discount for minority interest and lack of marketability to be applicable. Rev. Rul. 93-12, 1993-1 CB 202. Rece |