Estate Taxes

Q: Will my estate be subject to death taxes?

Under current federal law most Americans do not have a federal estate tax problem. Under the 2010 Tax Relief Act (formally abbreviated as TRUIRJCA 2010), every individual has a $5 million federal estate tax exemption. If you do not need that entire amount, the balance of your exemption is portable to your surviving spouse when they later die. So for married couples, it is fairly easy to shelter $10 million from federal estate taxation with little or no planning done in advance.

Many states, however, impose a separate estate tax that is often more widely applicable than the federal estate tax. Because the state and federal estate tax systems are often out of sync, it is important to coordinate your estate plan in a way that maximizes your estate tax planning opportunities to ensure that you pay as little in estate tax as possible.

Moreover, proper tax planning in the estate planning context must contemplate income tax planning opportunities for you and for your heirs as well as capital gains, generation skipping transfer, and other tax systems.

Q: What is my taxable estate?

Your gross estate for federal estate tax purposes includes:

All property that you own at death (e.g., real estate, investments, business interests, personal property, mortgages held by you);
Property you have given away while retaining a lifetime interest in the income from the property, the use and enjoyment of the property, or the right to determine who ultimately receives the property;
Gifts that don't take effect until you die;
Property that you own jointly with another person except to the extent the other party contributed to the purchase price of the property;
Property over which you possess a general power to appoint the property to yourself or others;
Life insurance policies owned by you or in which you retained the right to change the beneficiary, cancel the policy, or make policy loans;
Your one-half interest in community property;
Annuities, pensions, and profit-sharing plans

From your total gross estate, your estate may take deductions for funeral expenses, administration expenses (e.g., executor's fees, court costs, attorney's fees, appraiser's fees), certain debts and income taxes, state death taxes paid, and property left to your U.S. citizen spouse or to qualified charities.

Q: What is the unlimited marital deduction?

A married individual can give an unlimited amount of assets, either by gift or bequest, to his or her spouse without any federal gift or estate taxes being imposed. This allows married couples to delay the payment of estate taxes at the passing of the first spouse because when the surviving spouse dies, all assets in the estate over the applicable exclusion amount will be included in the survivor’s taxable estate. Please note: the unlimited marital deduction is available solely to surviving spouses who are citizens of the United States.

Q: What is a Credit Shelter or A/B Trust and how does it work?

A Credit Shelter Trust, also known as a Bypass or A/B Trust, is used to reduce or eliminate federal estate taxes. It is generally used by married couples with estates exceeding amounts exempt from federal estate tax. Upon the death of the first spouse, the Credit Shelter Trust establishes a separate, irrevocable trust with the deceased spouse’s share of the trust’s assets. The surviving spouse becomes the beneficiary of this trust, with the children as beneficiaries of the remaining interest. This irrevocable trust is funded to the extent of the first spouse’s exemption, meaning the amount in the irrevocable trust is not subject to estate taxes on the death of the first spouse. In effect, the Credit Shelter Trust takes full advantage of the first spouse’s estate tax credit.

Q: What is a Qualified Personal Residence Trust (QPRT) and how does it work?

A Qualified Personal Residence Trust (“QPRT”) is a type of trust specifically authorized by the Internal Revenue Code. It permits you to transfer ownership of your residence to your family during your lifetime and retain the exclusive right to live in the residence, while reducing the size of your estate for estate tax purposes.

The residence is transferred to the Qualified Personal Residence Trust for a designated initial term of years. Provided you survive the initial term of years, ownership of the residence will be transferred to your family at a fraction of its fair market value. If you die during the initial term of years the property will be brought back into your estate, but you will be no worse off than had you not created the Qualified Personal Residence Trust. You may transfer up to two (2) personal residences into Qualified Personal Residence Trusts.

The Qualified Personal Residence Trust is a particularly noteworthy estate planning tool to reduce federal estate taxes because it permits you to transfer a residence out of your taxable estate while retaining the right to use it during your lifetime. The gift for federal gift tax purposes is based upon IRS published interest rates at the time of the transfer, and this rate does not take into consideration actual appreciation in the value of the property. Accordingly, these trusts are particularly useful to transfer residences in which significant future appreciation is anticipated. The Qualified Personal Residence Trust permits you to continue to enjoy your residence, knowing that the value at the date of death will not be included in your estate.

During the term of years of the trust you have the absolute right to remain in the residence rent free. After the initial term you can be granted the right to rent the residence for the balance of your lifetime for its fair rental value.

During the term of years, you can be the sole trustee or a co-trustee of the trust with complete control over all decisions of the trust and the assets in the trust. You may also sell the residence and buy another residence during the trust term.

Because the Qualified Personal Residence Trust is a grantor trust under the income tax laws, during the initial term of years you are treated as the owner of the property for income tax purposes. Therefore, all items of income, gain, loss and deduction with respect to the trust are treated on your personal income tax return.   So for example, the deduction for real estate taxes remains available to you. In addition, favorable capital gains treatment, including capital gain rollover and the $250,000 exclusion of gain are still available to you.

Q: What is an Irrevocable Life Insurance Trust and how does it work?

Life insurance is a unique asset in that it serves numerous diverse functions in a tax-favored environment. Life insurance proceeds are received income tax free and, if properly owned by an Irrevocable Life Insurance Trust, life insurance proceeds can also be received free of estate tax.

An Irrevocable Life Insurance Trust (ILIT) is one of the most popular wealth planning devices. It is a trust designed to own a life insurance policy, usually on the lives of you and your spouse.   You gift funds to the trust periodically and the trustee uses the funds to pay premiums on the life insurance policy. The trust is designed to produce benefits for your family.

•    Make current gifts to family members.
•    Accumulate assets outside the client’s taxable estate.
•    Protect assets from claims of creditors.
•    Avoid income tax on the accumulation of funds.
•    Avoid estate tax upon the distribution of funds to the family.
•    Create a source of liquidity to cover estate taxes or expenses.
•    Replace assets that may have been given to charity.

Q: What is a Family Limited Partnership and how does it work?

Understanding how, why and when a Family Limited Partnership (“FLP”) will work for you as an Asset Protection vehicle is critical. The FLP is one of the most important Asset Protection tools in use today. Effectively drafted and funded it can act as a significant hurdle to a creditor seeking to attach your wealth. However, it is also one of the most misunderstood vehicles as well. A quick search on the net will reveal much confusing and often conflicting information. The FLP is also often mistakenly referred to as the Family Trust or Family Limited Trust. All Limited Partnerships are governed under the statutes of the state in which they were created. While these State laws are for the most part similar, there are some important differences when it comes to creditor protection. The FLP is a popular and common business and estate-planning tool, and over the past 20 years has become a mainstay of Asset Protection as well.

A typical family limited partnership will consist of general partnership units being wholly owned by a parent or an entity wholly owned by a parent. Likewise, the parent or parents will also own a majority of the limited partnership interest, either individually or through wholly owned entities. As time progresses, additional family members can be added to the roster of limited partners and gain some tax advantages for the parents in the process, all while the creators of the FLP maintain total control and limited liability.

The Wealth Solutions Counsel is a practice group of Keith, Miller, Butler, Schneider, and Pawlik, PLLC. The Wealth Solutions Counsel assists clients with Estate Planning, Wills and Trusts, Wealth Preservation, Asset Protection, Planning for Children, Estate Taxes, Tax Law, Tax Preparation, Business Law, Business Succession Planning, Special Needs, and Probate and Estate Adminisration, in Rogers, Fayetteville, Bentonville, and Springdale, and in both Benton County and Washington County, Arkansas.