• News Room
• Articles
• VanCott Magazine

Ten Strategies for Reducing Estate Tax

Whether your goal is transferring assets to the next generation, benefiting philanthropic organizations, or simply minimizing potential estate taxes, you have a variety of estate planning strategies from which to choose.

1. Take advantage of your "applicable exclusion amount." Federal estate tax laws currently allow an individual to shelter $2 million from the 45 percent estate tax. Through proper estate planning, including the use of trusts and the proper titling of assets, a married couple can shelter $4 million from estate tax while still making the assets of the first-to-die available for the support and maintenance of the surviving spouse.

2. Make annual exclusion gifts. Federal gift tax laws currently allow an individual to give $12,000 annually to each of as many donees as he or she desires without being subject to the 45 percent gift tax. The methods available for accomplishing these "annual exclusion gifts" range from making relatively simple outright gifts of cash or other assets to more complicated techniques such as gifting interests in family limited partnerships or limited liability companies and paying premiums with respect to irrevocable life insurance trusts.

3. Create a family limited partnership or limited liability company. Use of a family limited partnership or limited liability company allows you to gift an asset while still maintaining some control (as general partner or manager) over the use and disposition of the asset. It also may allow you to discount the value of the partnership or company interests being gifted due to the recipient's lack of control over the entity and restrictions on transfers imposed by the entity's governing documents. By taking advantage of valuation discounts, you are able to proportionately increase the amount of underlying property transferred without exceeding the annual exclusion amount of $12,000.

4. Pay children's and grandchildren's medical and educational expenses. In addition to the $12,000 annual exclusion from the gift tax, there is also a gift tax exclusion for paying an educational organization for the cost of a donee's tuition, or for paying a provider of medical care for a donee's medical expenses.

5. Create a charitable remainder trust (CRT) and fund it with highly appreciated assets. A CRT is an irrevocable trust that pays you a fixed annuity or a fixed percentage of the assets of the trust, not less frequently than annually, for a term of years or life, and, at the end of the term, distributes the remaining assets to a charity designated by you. The transfer of assets to a CRT is not a taxable event and does not trigger capital gains tax. However, in the year of the transfer you receive an income tax deduction equal to the value of the charity's remainder interest. The CRT can sell the appreciated assets without triggering payment of a capital gains tax, although the annual payments must be reported on your individual tax return to the extent they represent capital gain or ordinary income. A private foundation can be an effective tool for involving your children in charitable endeavors.

6. Establish a private foundation to be controlled by you and your family. Contributions to private foundations are deductible for income and gift tax purposes during life, and for estate tax purposes at death. The foundation makes annual distributions of most of its income for charitable purposes as determined by you and your family.

7. Create a grantor retained annuity trust (GRAT). A GRAT pays you a fixed annuity for a term of years specified by you. At the end of the term, the remaining assets are distributed to your beneficiaries. If the actual value of the remainder exceeds the projected future value of the remainder determined according to IRS tables, the excess passes to your beneficiaries without the imposition of any gift or estate tax, provided you survive the term of the GRAT. A GRAT is particularly effective with rapidly appreciating assets.

8. Create a qualified personal residence trust (QPRT). A QPRT is similar to a GRAT except that instead of receiving a specified annuity, you retain the right to use your primary or secondary residence during the term of the QPRT. Like a GRAT, the value of the gift is equal to the remainder interest, and is determined by subtracting the value of your retained interest from the value of the property at the time the QPRT is established. During the term of the QPRT, you retain control over the residence. Assuming you survive the term, the residence passes to your beneficiaries without the imposition of additional gift or estate tax, although you may continue to live there rent-free, depending on the circumstances.

9. Make lifetime gifts to the extent of your lifetime gift tax exclusion. The estate tax is calculated on a tax inclusive basis, while the gift tax is calculated on a tax exclusive basis. This means that the amount of gift tax paid on a taxable gift is not itself subject to tax, provided that you live at least three years after the date of the gift. As an example, assuming a 45 percent gift tax rate, a lifetime gift of $1 million would trigger a gift tax of $450,000 ($1 million x .45), requiring a total of $1,450,000 to make the transfer. On the other hand, assuming a 45 percent estate tax rate, to transfer that same $1 million to your beneficiaries at death would require a total of $1,818,182, with an estate tax to be paid of $818,182 ($1,818,182 x .45). The difference between the gift tax and the estate tax in this case is $368,182. In addition, a lifetime transfer has the advantage of accomplishing an estate freeze in which all future income and appreciation in the property passes to your beneficiaries, rather than to you. The lifetime gift tax exemption is currently $1 million per person.

10. Avoid successive taxation by making generation-skipping transfers. In the event your children are likely to be in a taxable estate situation themselves, anything you add to their estates could be subject to the estate tax at their deaths as well. You can avoid this problem of successive taxation by skipping your children's generation and making transfers directly to your grandchildren. To limit this type of generation-skipping transfer, Congress has imposed a 45 percent generation-skipping transfer tax on such transfers in addition to the estate or gift tax. However, each individual has a generation-skipping transfer tax exemption of $2 million. This means that a married couple, with proper estate planning, can transfer $4 million to grandchildren without having that amount taxed at their children's deaths and without paying the additional generation-skipping transfer tax.