Will my estate be
subject to death taxes?
What is my taxable estate?
What is the unlimited marital deduction?
What is a Credit Shelter or A/B Trust and how
does it work?
What is a Qualified Personal Residence Trust
(QPRT) and how does it work?
What is an Irrevocable Life Insurance Trust
and how does it work?
What is a Family Limited Partnership and how
does it work?
Q: Will my estate be subject to death taxes?
There are two types of death taxes that you should be
concerned about: the federal estate tax and state estate
taxes. The federal estate tax is computed as a percentage of
your net estate. Your net estate comprises of all assets you
own or control are part of your taxable estate minus certain
deductions. Such deductions can be for charitable donations as
well as an applicable exclusion amount. The applicable
exclusion amount varies from year to year: In the year 2007
through 2008, it is set at $2,000,000 per year, which means that
you may pass on up to that amount in those years without being
subject to any federal estate tax. The applicable exclusion
amount is set to increase to 3,500,000 in the year 2009. The
federal estate tax is repealed for the year 2010, but the
repeal sunsets on December 31, 2010 and the applicable
exclusion amount goes back to $1,000,000 for 2011 and onward.
Even if you believe that that you may not be affected by the
federal estate tax, you still need to determine whether you may
be subject to state estate taxes and whether you will have a
taxable estate in the future as your assets appreciate in value.
You should regularly review your estate plan with an experienced
estate planning attorney to make adjustments to reflect changes
in the tax laws as well as shifts in your individual
circumstances.
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Q: What is my taxable estate?
Your taxable estate comprises of the total value of your assets
including your home, other real estate, business interests, your
share of joint accounts, retirement accounts, and life insurance
policies - minus liabilities and deductions such as funeral
expenses paid out of the estate, debts owed by you at the time
of death, bequests to charities and value of the assets passed
on to your U.S. citizen spouse. The taxes imposed on the taxable
portion of the estate are then paid out of the estate itself
before distribution to your beneficiaries.
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Q: What is the unlimited marital deduction?
The federal government allows every married individual to give
an unlimited amount of assets either by gift or bequest, to his
or her spouse without the imposition of any federal gift or
estate taxes. In effect, the unlimited marital deduction allows
married couples to delay the payment of estate taxes at the
passing of the first spouse because at the death of the
surviving spouse, all assets in the estate over applicable
exclusion amount ($2,000,000 in 2007) will be included in the
survivor's taxable estate. It is important to keep in mind that
the unlimited marital deduction is only available to surviving
spouses who are United States citizens.
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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 eliminate or reduce federal estate taxes and is
typically used by a married couple whose estate exceeds the
amount exempt from federal estate tax. For example, in 2007,
every individual is entitled to an estate tax exemption on the
first $2 million of their assets. This amount is scheduled to
rise to $3.5 million in 2009.
Because of the Unlimited Marital Deduction, a married person may
leave an unlimited amount of assets to his or her spouse, free
of federal estate taxes and without using up any of his or her
estate tax exemption. However, for individuals with substantial
assets, the Unlimited Marital Deduction does not eliminate
estate taxes, but simply works to delay them. This is because
when the second spouse dies with an estate worth more than the
exemption amount, his or her estate is then subject to estate
tax on the amount exceeding the exemption. Meanwhile, the first
spouse's estate tax credit was unused and, in effect, wasted.
The purpose of a Credit Shelter Trust is to prevent this
scenario. 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 is 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. Thus,
the amount in the irrevocable trust is not subject to estate
taxes on the death of the first spouse, and the trust takes full
advantage of the first spouse's estate tax credit. Special
language in the trust provides limited control of the trust
assets to the surviving spouse which prevents the assets in that
trust from becoming subject to federal estate taxation, even if
the value of the trust goes on to exceed the exemption amount by
the time the surviving spouse dies.
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Q: What is a Qualified Personal Residence Trust (QPRT) and how
does it work?
Our homes are often our most valuable assets and hence one of
the largest components of our taxable estate. A Qualified
Personal Residence Trust, or a QPRT (pronounced cue-pert)
allows you to give away your house or vacation home at a great
discount, freeze its value for estate tax purposes, and still
continue to live in it. Here is how it works: You transfer the
title to your house to the QPRT (usually for the benefit of your
family members), reserving the right to live in the house for a
specified number of years. If you live to the end of the
specified period, the house (as well as any appreciation in its
value since the transfer) passes to your children or other
beneficiaries free of any additional estate or gift taxes.
After the end of the specified period, you may continue to live
in the home but you must pay rent to your family or designated
beneficiary in order to avoid inclusion of the residence in your
estate. This is may be an added benefit as it serves to further
reduce the value of your taxable estate, though the rent income
does have income tax consequences for your family. If you die
before the end of the period, the full value of the house will
be included in your estate for estate tax purposes, though in
most cases you are no worse off than you would have been had you
not established a QPRT. An added benefit of the QPRT is that it
also serves as an excellent asset/creditor protection vehicle
since you no longer technically own the property once the trust
is established.
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Q: What is an Irrevocable Life Insurance Trust and how does it
work?
There is a common misconception that life insurance proceeds
are not subject to estate tax. While the proceeds are received
by your loved ones free of any income taxes, they are countable
as part of your taxable estate and therefore your loved ones can
lose over forty percent of its value to federal estate taxes.
An Irrevocable Life Insurance Trust keeps the death benefits of
your life insurance policy outside your estate so that they are
not subject to estate taxes. There are many options available
when setting up an ILIT. For example, ILITs can be structured
to provide income to a surviving spouse with the remainder going
to your children from a previous marriage. You can also provide
for distribution of a limited amount of the insurance proceeds
over a period of time to a financially irresponsible child.
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Q: What is a Family Limited Partnership and how does it work?
A Family Limited Partnership (FLP) is simply a form of a limited
partnership among members of a family. A limited partnership is
one which has both general partners (who control management) and
limited partners (who are passive investors). General partners
bear unlimited personal liability for partnership obligations,
while limited partners have no liability beyond their capital
contributions. Typically, the partnership is formed by the older
generation family members who contribute assets to the
partnership in return for a small general partnership interest
and a large limited partnership interest. Then the limited
partnership interests are transferred to their children and/or
grandchildren, while retaining the general partnership interests
that control the partnership.
The FLP has a number of benefits: Transferring limited
partnership interests to family members reduces the taxable
estate of the older family members while they retain control
over the decisions and distributions of the investment. Since
the limited partners cannot control investments or
distributions, they can be eligible for valuation discounts at
the time of transfer which reduces the value of their holdings
for gift and estate tax purposes. Lastly, a properly structured
FLP can have creditor protection characteristics since the
general partners are not obligated to distribute earnings of the
partnership.
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