Simple Steps to Reduce Estate Tax

Some estate-planning strategies are highly complex.  It’s best to start with what’s simple.

Annual Exemption

For large families, the Annual Exemption ($14,000 per year to each individual donee) is especially important. If you have three children and six grandchildren, for example, you and your spouse can make exempt gifts to them totaling $256,000 per year.

Time is on your side in exploiting the Annual Exemption. Obviously, the sooner you begin using it, and the longer you live, the more you can give. Less obvious, perhaps, is that as soon as you make a gift, you push all the gift’s future earnings out of your taxable estate.

Lifetime Credit Amount

Any portion of the $5.45 million tax-free amount that you use for lifetime gifts will be unavailable to your estate. Nevertheless, the advantage of keeping future earnings out of your taxable estate argues for using as least part of the $5.45 million tax-free amount sooner rather than later.

“Soon” is a prudent general rule to apply to any opportunity to transfer assets without incurring tax. The rules can change — as they already have many times. The exemption, deduction or credit you postpone using may not be available tomorrow.

Spousal Deduction

Depending on family circumstances, amounts that cannot be transferred to a younger generation without tax usually should be left outright to a surviving U.S. spouse or left in a trust (such as a Model Offshore Trust) with QTIP provisions. The result, because of the spousal deduction, is that the estate of the first spouse to die escapes all tax.

Constraints

Several factors can hinder a plan to reduce gift and estate tax by making lifetime gifts.

  • You don’t want to plan yourself into the poorhouse by giving away money you later will need.
  • Making large gifts too soon to your children or other prospective heirs may be harmful to them.
  • You want to be confident the wealth you have accumulated will be invested wisely.

Successful planning for large estates depends very much on overcoming these three obstacles.

Concern for how gifts will be managed and used often can be satisfied by avoiding outright gifts of cash or of investments that are readily salable. To encourage accumulation of wealth by the recipients, for example, you may make gifts of stock in a family corporation or gifts of interests in a family investment partnership. Or, to prevent hasty spending by the recipients and to provide for competent investment management, you may make gifts in trust.

Exploiting the opportunities for lifetime giving without jeopardizing your own financial security is a more difficult problem. Part of the solution is simple arithmetic. Make a generous estimate of how much capital you need in order to live in complete comfort. Any capital beyond that amount would be available for a program of exempt transfers to your prospective heirs.

Secondly, you can enter into income-assuring transactions with a trust established for your prospective heirs. Because they protect your income, such transactions free you to speed up your program of exempt giving. They also can, in and of themselves, reduce the size of your taxable estate. And they keep assets from passing into your children’s hands too soon and assure that the transferred capital will be invested wisely.

Anything you do to reduce gift and estate tax probably will reduce the potential liability for generation-skipping tax as well.

If your taxable estate is likely to exceed $5.45 million (or $10.9 million for a married couple), the simple measures discussed on this page may not be sufficient to completely protect your family from estate tax.  See Advanced International Estate Planning for strategies for avoiding tax on even the largest estates.

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