In 2005, the amount of your taxable estate above $1,500,000
is subject to estate taxes at a rate of approximately 45%.
For example, if you die with an estate of $2,500,000, $1,000,000
will be subject to estate taxes.
Below we discuss:
- The core terms of estate tax planning
- Basic techniques for reducing your estate taxes
Even though the goal of reducing taxes is straightforward,
remember that implementing a more sophisticated estate tax-planning
techniques requires the assistance of an attorney.
Unified credit exemption
This refers to maximum amount of assets the IRS allows a tax
payer to transfer tax-free during life or at death. Currently
the unified credit is $1,500,000, and $2,000,000 for 2006.
Unlimited marital transfer
The IRS allows spouses who are both U.S. citizens to transfer
unlimited amounts of assets to one another tax-free. Special
rules apply to non-U.S. citizen spouses.
The IRS allows a person to give an unlimited number of gifts
of up to $11,000 annually, without using their unified credit
Basic Estate Tax Planning Techniques
The following techniques form the cornerstones of most estate
Credit shelter trust
This type of trust, also know as a bypass trust or an exemption
trust, is probably the single most effective estate planning
tactic you can use. This common technique encourages couples
take advantage of both spouses' unified credit exemption (instead
of just one spouse).
Upon the death of a spouse, if his or her assets are simply
shifted to the surviving spouse, you lose the opportunity
to use that spouse's unified credit exemption. With a credit
shelter trust, a couple can transfer up to $3,000,000 tax-free,
rather than just $1,500,000 and possibly save $450,000 in estate taxes.
When you create a credit shelter trust, you:
- Create a trust that takes advantage of your unified credit
- Name the beneficiary (often your spouse) who can receive
income from the trust.
- Name the final beneficiaries for the trust.
- Transfer the assets to the final beneficiaries tax-free.
Even if your spouse is the income beneficiary, it will not
count as part of their estate.
Qualified terminable interest property trust (QTIP)
These trusts are often used to complement credit shelter
trusts. Combined with a bypass trust, the QTIP has the potential
to eliminate all estate taxes upon the death of the first
spouse. Many people pair the QTIP with a bypass trust, a combination
that estate planners call an A-B trust arrangement.
The QTIPs are a specialized--and tax-advantaged--way of taking
advantage of the unlimited marital transfer of assets. Here's
how they work:
- You transfer assets into a QTIP that's part of your spouse's
- You get to name the final beneficiaries of that trust.
- While your spouse is alive, he or she receives the income
generated by this trust.
- Upon your spouse's death, the assets pass to the final
By shifting assets to a spouse whose taxable estate is lower
than yours (or whose taxable estate is lower than the unified
credit exemption limit), you can reduce or eliminate the estate
taxes that the two of you will pay.
QTIPs are now more attractive than ever because the unified
credit exemption is currently $1,500,000 and $2,000,000 for 2006. The longer that your spouse outlives you, the more
likely that delaying paying estate taxes will pay off because
the estate tax limit is increasing.
After taking advantage of your unified credit exemption,
gifting is one of the most effective (and easiest) ways to
reduce the size of your taxable estate.
The annual $11,000 exclusion is an effective way to reduce
the size of your estate (married couples can give $22,000).
Each year, you can give $11,000 to as many people as you wish
without incurring transfer tax. For example, for a $2 million
estate, if you were to give $22,000 every year to your two
children, their spouses, and your four grandchildren, you
would cut the size of your estate in half in 6 years and avoid
paying approximately $440,000 in taxes.
Beyond this $11,000 limit, a person can "gift"
an unlimited amount for tuition and medical expenses. An important
note: in order for this gift not to count against your unified
credit exemption, you must pay the school or healthcare provider
Giving more than $11,000
Giving away assets before death (instead of after) can make
If you have an asset whose value you expect to appreciate
rapidly (homes are a classic example), it may be a good idea
to gift it before its value appreciates and consumes an even
larger portion out of your unified credit exemption.
Once you have passed the unified credit exemption limit,
giving gifts makes even more sense because the effective tax
rate on gifts is lower than on an estate. Gift tax is calculated
like a sales tax; the amount of the gift is multiplied by
the tax. Estate taxes, however, are levied on the entire estate,
including the money you send the IRS to pay those very estate
Giving to charitable organizations
When you give cash or assets that you have held for longer
than a year to charity, you can deduct from your taxes the
appreciated value of the assets (not your original costs),
translating to potentially substantial tax savings.
For example, if you give a charity $50,000 in stock that
cost $7,000, you can take a $50,000 deduction.
Charitable remainder trust
Charitable remainder trusts are very effective estate planning
vehicles. Because of their rather sophisticated structure,
they require the help of a professional. Very simply, this
is how they work:
- You gift assets into a charitable trust, which is irrevocable.
- You can take a tax deduction on the gift that will pass
to charity at the end of the trust term; the amount is discounted
at a predetermined rate.
- The charitable trust pays you a certain amount for a predetermined
amount of time.
- At the end of the term of the trust or at your death,
the remaining principal in the trust goes to the charity
of your choice.
Why do this? By creating a charitable remainder trust, you
can reduce capital gains taxes and other taxes you would incur
by either selling those assets or keeping them as part of
your estate. This way, you enjoy some income from these assets
and give them to charity at the end of the trust term.