As many of you know from past Legal Update articles, it is important to plan for your financial future. The recession which has followed us into 2009 continues to put fear into the stock market, real estate market and, most of all, each of us individually. What does the future hold for us, our children and grandchildren? No one can say at this point. However, you can begin to take control of your financial future by planning appropriately.
Each individual should review his or her assets and family situation and put a Will, Power of Attorney and Health Care Directive (Living Will) in place. Basic estate planning documents should take advantage of the maximum tax credits afforded to individuals for estate (unified credit) and generation-skipping transfer tax planning (GST exemption). Using these credits minimizes the amount of tax that must be paid to the Internal Revenue Service, or state taxing authorities, at death. Thus, the maximum amount of assets will pass to your heirs. This type of planning can also be completed during an individual’s lifetime. Through carefully drafted estate planning documents, assets can be transitioned during life or at death to your heirs with the minimum imposition of estate, gift and generation-skipping transfer taxes.
The unified credit shields property from tax, regardless of to whom such property passes. The amount shielded by the unified credit is known as the “applicable exclusion amount.” For 2009, the applicable exclusion amount is $3,500,000. The estate tax is repealed in 2010. Unfortunately, the applicable exclusion amount sunsets back to $1,000,000 in 2011. It is advantageous for property to pass tax free as part of the applicable exclusion because the applicable exclusion escapes tax at death. The GST exemption is currently $3,500,000 and permits property to pass generation to generation tax free. However, due to the impending elimination of the estate tax, we believe that the estate tax laws will be changed in short order. However, there is no certain change proposed at this time.
Notwithstanding the possible changes, we believe that the estate tax will remain both for Federal and for State estate tax purposes. Therefore, there is still a need to address the estate tax in your lifetime planning and in the documents which take effect at death. Due to the depressed state of our economy and the low interest rates set by the government, currently there are very effective lifetime planning tools that we recommend and use for our clients:
Gifting: Annual exclusion gifting is the easiest way to transfer assets to your children, grandchildren and great-grandchildren tax free. There is no reporting requirement on these gifts. These gifts will reduce your estate for estate tax purposes and all growth on the assets will be out of your estate. The following outlines what qualifies for annual exclusion gifts: The amount you can give to each donee each year is $13,000 per donee ($26,000 for each donee from a married couple). This amount is indexed for inflation. You can also make payments directly to educational institutions and medical providers for educational expenses and medical expenses for your family. All these gifts are tax free and do not need to be reported on a gift tax return. You can also gift up to $1,000,000.00 during your lifetime, in excess of annual exclusion gifts. These gifts must be reported on a gift tax return, but no gift tax is payable if the total of the taxable gifts does not exceed $1,000,000. We have always been believers of using the gift tax applicable exclusion amount ($1,000,000) during your lifetime in circumstances where appropriate. The advantage is you give away the appreciation on the gifted amount free of transfer tax. Leveraging a gift is the best way to make the most of annual exclusion gifting.
Irrevocable Life Insurance Trust: The proceeds of an insurance policy can be completely protected from estate taxes by putting the policy into an Irrevocable Life Insurance Trust. The grantor of such a trust must survive for three (3) years from the transfer of an existing life insurance policy into the Trust, for the proceeds to become shielded from estate tax. Any policy purchased by the Trust is immediately protected from estate tax. There are certain requirements in the administration of such a trust; however, the planning technique is very effective in saving estate taxes.
Qualified Personal Residence Trusts (QPRT): A QPRT is a trust which reserves to the grantor the right to occupy a personal residence transferred to the trust for a term of years. The gift tax value of the transfer is only a fraction of the property’s true value because of the retention by the grantor of the right to occupy the property for a set term and the risk that the grantor will die during the term of the trust term. At the end of the trust term the property passes to designated beneficiaries, either outright or in trust for the remainder beneficiaries. The grantor may rent the property from the beneficiaries or the trust (thus removing the value of the rental income from estate tax). This technique works well when there is a piece of property that will remain in the family for some time.
Grantor Reported Annuity Trust (GRAT): The placing of assets in trust for a limited term with a guaranteed annual annuity payable to the grantor provides valuation discounts. It is well-suited for appreciating assets. The GRAT works exceptionally well with assets that are valued at a discount. This is a good time to consider a GRAT because interest rates are low. (The 7520 rate for September 2009 is 3.4%; this is the rate used to value the remainder gift in the trust.) It is not necessary for the remainder interest in the GRAT to pass outright to the remainder beneficiaries at the end of the term. The remainder interest may instead pass to a trust for the benefit of the remainder beneficiaries. A GRAT will work well where the anticipated appreciation of the GRAT assets during the GRAT term is likely to be greater than the 7520 rate and where the income generated by the GRAT assets is sufficient to pay the annuity amount to the grantor of the trust. Also, all of the GRAT income is taxable to the grantor of the trust. This provides a “tax free” growth of the assets for the remainder beneficiaries.
No matter what you decide to consider in connection with your estate planning, some planning is better than no planning at all. Even if you decide to put “just” the basic documents in place, you are ahead of those who did not consider planning at all. In the end, you save your hard-earned money for your children, grandchildren and more remote generations!