Federal Estate Tax And Estate Planning

Deborah L. Jacobs of the New York Times wrote the following article entitled: “Do the estate tax limbo: Financial strategies while we wait to see what happens”

The federal estate tax is scheduled to rise from the ashes next Jan. 1, and a lot more families may feel its bite unless Congress changes current law.

The resulting uncertainty about what Congress might do, and if and when Congress might do it, is complicating financial planning. It’s a particular burden to the retired, who must find a balance between what they need to live on and how much they might give away to avoid estate taxes.

Fortunately, a number of strategies are available, and not all of them involve depleting your resources.

The amount of each estate that is exempt from estate tax is scheduled to become $1 million in 2011. That’s down from $3.5 million in 2009, when the tax was last in effect. The tax on the balance is to rise to 55 percent in most cases. And that’s up from the 2009 rate of 45 percent.

Here are some tax strategies to consider.

Give it away
The easiest way to reduce the tax bill is to give as much as $13,000 a year each to as many people as you like – which you can do without paying gift tax.

Spouses can combine this annual exclusion to give $26,000 jointly to each of as many people as they would like, or they can give the money to a trust for someone’s benefit.

To give away more than that, you can count your gift against the $1 million lifetime exemption – the total of taxable gifts each person can make without incurring a gift tax.

Life insurance
During this period of uncertainty, buy a one- or two-year term policy to cover the tax bill if the exemption amount is only $1 million, said Ann B. Burns, a lawyer with Gray Plant Mooty. The policy can be canceled if Congress eases your estate tax concerns.

Be sure that your beneficiaries, not you, own the policy, or the proceeds will count as part of your estate and could be subject to tax. As owners, your beneficiaries must pay the premiums, but you can give them the money to do that using annual gifts. If you already own a policy, sell it to the trust or to family members for its fair market value.

Get married
A widow or widower who remarries gains the estate tax advantage available to all married couples: you can leave an unlimited amount to your spouse – provided she or he is an American citizen – with no estate tax applied. The assets must be left outright or in a certain type of trust.

In the process, though, the remarrying widow or widower would lose the late spouse’s Social Security benefits, said Joshua S. Rubenstein, a lawyer with Katten Muchin Rosenman.

This strategy affects only the assets your deceased spouse left to you; assets left to other beneficiaries are unaffected.

Make a loan
If you lend money to family members – say, to buy a house or a car or to start a business – you create a win-win situation.

You must charge a minimum rate of interest set each month by the Treasury, called the applicable federal rate, to avoid potential gift tax and income tax consequences.

For September, the rate for loans lasting more than nine years and requiring monthly payments is an attractive 3.6 percent.

Go to college
Section 529 education savings plans are primarily a tool for financing education – your own or a family member’s. Earnings in the account are exempt from federal tax, provided the money is withdrawn to pay for tuition or certain expenses for college or graduate school.

Another attraction of these accounts is that you can tap the money yourself if you need it, making 529 accounts a good way to hedge your bets. To have this option, you must name yourself as the owner, said Susan T. Bart, a lawyer with Sidley Austin.

The law permits lump-sum deposits, using the annual exclusion, of as much as $65,000 a person at once or $130,000 for married couples, provided you file a gift tax return that treats the gift as if it had been spread over five years. If you die before the five years is up, the part of the gift that reflects the number of years still to go will be considered part of your estate.

Make a trust
With a grantor retained annuity trust, known as a GRAT, you put appreciating assets into an irrevocable trust and retain the right to receive an annual income stream for the term of the trust.

This annuity is based on the Section 7520 rate set each month by the Internal Revenue Service. If you survive the trust term – a condition for this technique to work – any appreciation above the set rate can go to family members or to trusts for their benefit. Under current law, it is possible to create a GRAT that will result in no taxable gift, or a nominal one.

These trusts are not appropriate for people who cannot stomach complexity, and they cost at least $5,000 to $10,000 to set up, Burns said. They work best for assets where rapid appreciation is expected, she said, for instance, when a company is sold or goes public.