Haimo Law - Wills, Trusts, Probate, Business Planning and Asset Protection

Shifting, Preserving and Protecting Wealth for Generations

Shifting, Preserving and Protecting Wealth for Generations

The amount of an estate that is exempt from estate tax is presently $5.25 million (“Unified Credit”). The rate of estate and gift tax that you can expect to pay above this amount is presently 40%. Aside from 2010 when there was no tax, it’s been as low as $1 million dollars and as high as $3.5 million dollars since 2001, with estate and gift tax rates as high as 55%!

You should know that the tax code expressly states that it is lawful to take every advantage available in the code to minimize taxes. In that light, it’d be a regrettable waste if a large amount of your money passes to the government instead of your family because you didn’t plan ahead. Here’s an advanced strategy that is employed to minimize estate and gift taxes, ensure assets are preserved and protected for subsequent generations (up to 360 years in Florida), while still retaining control over them.

Let’s look at an example: say you have $15 million dollars in your estate and die in 2013 with no estate plan. If you’re unmarried, after you reduce your estate by $5.25 million (unified credit), you’re looking at roughly $10 million in assets that will be subject to estate tax at 40%, totaling $4 million in tax. If you’re married, you can timely elect to apply your late spouse’s unified credit under what’s called “portability”. In that case, you may incur 40% of $5 million, or $2.5 million in tax. If you fail to make the election, the amount of tax will double.

Looking further ahead at better economic times, if your spouse doesn’t plan ahead, your spouse or beneficiaries (depending on apportionment of estate tax) may be hit with a significantly larger estate tax bill 9 months after his/her death, especially if you own appreciating assets. Think about how much estate tax would be due if your assets appreciated to $22 million upon the death of your surviving spouse. To prevent this fate, you’d certainly want to take advantage of the unlimited marital deduction and portability mentioned above. As a result, you’d likely reduce the value of the estate on the death of the surviving spouse by about $10 million, leaving $12 million subject to 40% estate tax, totaling $4.8 million in tax that goes to the government instead of your family. There’s ways to substantially reduce the value of your estate using trusts, one of the benefits of which is to freeze the current value of assets now while shifting the appreciation of the assets to your beneficiaries gift tax free. In other words, returning to the simplified example, you may have been able to reduce the value of your estate to the value of you and your spouse’s combined unified credits, thus eliminating estate tax and saving your family $4.8 million dollars in tax. Even if legal fees were to cost $1 million to do this type of tax planning it would be worth it. Guess what? It doesn’t. The only reason people with substantial wealth do not engage in tax planning is that they are unaware of the strategies that are available to them.

Here’s an overview of one way to structure this type of tax planning strategy. Please note that it is complicated and must be drafted correctly to work properly.

You form an irrevocable grantor trust, sometimes referred to as an intentionally defective grantor trust (“IDGT”). You are the initial trustee thereby retaining control over the assets. You are free to appoint successor trustees and designate beneficiaries as you wish. You can even structure the trust to endure for up to 360 years in Florida. Of critical importance is that your beneficiaries’ interests are protected from themselves, if financially irresponsible, and their creditors, including former spouses (from a divorce).

Logistically, you can fund the trust or lend it money evidenced by a promissory note at market interest rates. The trust, in turn, either invests in opportunities or purchases assets from you in a substantiated asset purchase and sale. The income to the trust is taxed to you as grantor until your death, at which time it becomes irrevocable and subject to its own income tax schedule. Importantly, upon your death, the value of the trust is excluded from the valuation of your estate for estate and gift tax purposes. What remains in your estate is the note you received from the sale of assets. The note is essentially “frozen” while the assets transferred to the trust appreciate in the trust, estate and gift tax free. This strategy is frequently referred to as an “asset freeze.”

As you can see, there are many strategies that you can employ to minimize estate, gift and generating-skipping transfer tax liabilities.