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Estate Tax-Minimizing Strategies

Virtually everyone needs a basic estate plan. A basic estate plan typically includes one or more health-care directives, a durable power of attorney, a will, and in some cases, a living trust. However, planning for the effect taxes can have on your estate and its transfer to your beneficiaries is just as important as the components of your estate plan. It is important to note that your estate will be taxed at both the federal and state level.

There are a number of strategies that may help you minimize estate taxes so that more of your money goes to your loved ones instead of the federal government. For example, if you want to leave a legacy to grandchildren or later generations, there are specific legal and tax issues that you'll need to consider (for example, the generation-skipping transfer tax). Similarly, If you own a family business or farm, you probably have unique planning concerns that may include transferring your business to your heirs in a way that doesn't disrupt operations, while taking advantage of special tax breaks. And if you're charitably inclined, there are strategies that help you arrange charitable gifts in a manner that best suits your financial situation.

Keeping Things In Balance

Estate tax-minimizing strategies generally come with tradeoffs that you should be aware of. These tradeoffs can come in the form of, implementation costs, relinquishment of financial benefits, the loss of control of your assets to a certain degree.

Implementing any estate planning strategy usually comes with a cost. For instance, you may need to hire an attorney to draw up legal documents, or you may need to hire an appraiser to determine the current fair market value of a property. Second, most estate tax planning strategies require you to give up some or all of the financial benefits from your property. For example, putting life insurance in an irrevocable trust to avoid estate taxes on the proceeds also precludes you from drawing on the policy's cash value. Most of the tax-minimizing strategies we'll look at require you to give up some degree of control over your property. For example, deeding your home to your children today will avoid estate taxes on the home's future appreciation, but, as the new owners, your children would have the legal right to evict you. 

The bottom line is that you must balance your objectives against the cost, making sure that the potential benefits of a strategy outweigh the costs. Now, let's look at some strategies that make the best use of the transfer tax exemptions, exclusions, and deductions. 

Decreasing the Estate Tax Burden

Each of these strategies helps minimize transfer taxes while achieving specific objectives. Whether any of these strategies are appropriate for you depends upon your particular circumstances. 

Some tax-minimizing strategies include:

  • Equalizing each spouse's estate - This strategy is best for spouses who have unequal estates. The spouse with the larger taxable estate can transfer assets to a spouse with smaller taxable estate and the transfer is not subject to transfer tax because of the marital deduction.
  • Optimizing the marital deduction - This strategy requires the first spouse who dies to leave an amount equal to estate the tax exclusion to children (the amount will not be taxed because of the estate tax exclusion). The balance of the estate is then left to the spouse and will not be taxed because of the marital deduction. And finally, the estate tax is deferred until the surviving spouse passes.
  • Qualified terminable interest property (QTIP) trust - Assets passing to QTIP trust qualify for the marital deduction and the surviving spouse receives all income from the trust for life, with access to the principal according to the terms of the trust. The remaining trust assets are then included in surviving spouse's taxable estate. At the surviving spouse's death, the remaining assets pass to the trust beneficiaries.
  • Bypass (credit shelter) trust  - This type of trust allows both spouses to fully utilize estate tax exclusions while giving the surviving spouse restricted access to more assets. Assets passing to the bypass (credit shelter) trust utilize the first spouse's exclusion. Upon the death of the surviving spouse, the remaining trust assets pass to beneficiaries according to terms of the trust. 
  • Dynasty trust - A dynasty trust preserves wealth for multiple generations of descendants, The trust survives twenty-one years after the death of the last beneficiary alive when the trust was created. This means it could last for over 100 years. Trust assets remain sheltered from transfer taxes (but not income taxes) while in the trust. 
  • Grantor retained annuity trust (GRAT) - Using this type of trust trust removes the property from your estate while allowing you to retain interest. The GRAT receives property an in return you (and your spouse) are paid an annuity for specific amount of time at which time the property transfers to your beneficiaries. However, the transfer is subject to gift tax but at a discounted value. The property is not included in the taxable estate as long as you outlive the term of years  
  • Qualified personal residence trust (QPRT) - This is a trust that is funded with a personal residence. With this type of trust you retain the right to live in the home for a specified number of years. So long as you outlive the specified number of years the home is not included in the taxable estate but at that time you must begin paying market-based rent if you continue living in the home.

If you have any concerns regarding the tax liability of your estate, reach out to us, we will provide clarity.

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