Estate Taxes

Will my estate be subject to death taxes?

What is my taxable estate?

What is the unlimited marital deduction?

What is a Credit Shelter, Bypass, 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?

The primary form of "death tax" is the federal estate tax and state estate taxes.  Federal estate taxes are very substantial, beginning at 37%. The federal estate tax is computed as a percentage of your net estate.  Generally speaking, your net taxable estate is comprised of all assets you own or control, plus any non-exempt lifetime gifts you have made, minus liabilities and certain deductions.  Such deductions may include assets passing to your spouse and certain charitable donations. It also includes a so-called “applicable exclusion amount”.  The applicable exclusion amount varies from year to year:  In the year 2008, it is set at $2,000,000, which means that you may pass up to that amount upon death in 2008 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  The federal estate tax is then “repealed” for the year 2010, but the repeal “sunsets” on December 31, 2010, and the applicable exclusion amount goes back to $1,000,000 for 2011 onward. 

In planning, you should take into consideration potential future growth of your estate. Even if you believe that you will not be affected by the federal estate tax, you still need to determine whether you may be subject to state estate taxes. These laws vary from state to state, and depending upon your assets or circumstances, your estate may be subject to the laws of multiple states.

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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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 who plan ahead to delay the payment of estate taxes at the passing of the first spouse. Any assets received from the deceased spouse, that the surviving spouse still owns or controls at his or her death, will be included in the taxable estate of the second spouse to die.

It is important to keep in mind that the unlimited marital deduction is only available to surviving spouses who are United States citizens. There is a limited deduction available for non-US spouses.

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A Credit Shelter Trust, also known as a Bypass Trust or A/B Trust, is used to reduce or eliminate federal estate taxes for a married couple whose estate exceeds the amount exempt from federal estate tax.  For example, in 2008, every individual is entitled to pass the first $2,000,000 of assets (minus any non-exempt lifetime gifts) free of federal estate taxes. This is known as the "applicable exclusion amount".

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 applicable exclusion amount . However, for individuals with substantial assets, the 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 applicable exclusion amount, his or her estate is then subject to estate tax on the excess.  Meanwhile, the opportunity to pass the applicable exclusion amount upon the first spouse's estate was unused and, in effect, wasted. The purpose of a Credit Shelter Trust is to prevent this scenario. Typically, a married person might provide in their Living Trust that, upon their death, a separate Credit Shelter Trust will be created for the benefit of their surviving spouse for their lifetime, with the balance remaining upon the survivor's death passing to the couple's children or other beneficiaries. Upon the trustmaker's death, this Credit Shelter Trust is then funded to the extent of their applicable exclusion amount. Thus, the amount in the Credit Shelter Trust is not subject to estate taxes on the death of the first spouse, the trust takes full advantage of the first spouse's opportunity to pass the applicable exclusion amount free of estate taxes, the trust nonetheless provides for the surviving spouse, yet with special language in the Credit Shelter Trust, its assets are not subject to federal estate taxation upon the death of the second spouse to die.

With this technique, a married couple may maximize what they may pass free of federal estate taxes. Using 2008 figures, a married couple might pass $4,000,000 in assets to their children free of estate taxes, instead of $2,000,000 if everything is left outright to the surviving spouse.

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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”), may allow 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 generally works. You transfer title to your house to the QPRT (usually for the benefit of your family members), but you reserve 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 QPRT 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 QPRT beneficiaries in order to avoid inclusion of the residence in your estate. This 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 QPRT beneficiaries. 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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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 37% or more 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.  Sometimes ILITs are used to create liquidity to pay estate taxes that are expected to be due on other assets, such as a family business. Sometimes ILITs are structured to provide a greater inheritance to meet the needs of your loved ones, and even to manage the inheritance over time. For example, the ILIT may manage income for your surviving spouse for their lifetime, with the remainder going to your children from a previous marriage, or it may provide for phased distribution of insurance proceeds to a financially irresponsible child.

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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. The limited partnership interests may then be transferred to their children and/or grandchildren, perhaps over time, while retaining the general partnership interests that control the partnership.

The FLP may have a number of benefits. It may provide a good structure for management of family assets, such as business interests, and transfer of ownership of such interests without yielding control. A properly structured FLP can have creditor protection characteristics, since the general partners are not obligated to distribute earnings of the partnership to the limited partners. And transferring limited partnership interests through gifts to family members reduces the taxable estate of the older family members while they retain control over the decisions and distributions of the investment. Furthermore, since the limited partners cannot control investments or distributions, transfers may qualify for valuation discounts for gift and estate tax purposes. 

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