The Federal Estate Tax Is Back and May Be Here to Stay

Despite the fact that 65% of taxpayers believe the federal estate tax is unfair, it’s back after a one-year repeal, and it could be here to stay.1

Some form of estate tax has been a part of the political landscape since 1797. Although it’s been repealed and reinstated many times, the federal estate tax appears to be as American as baseball and apple pie.

The 2010 Tax Relief Act reinstated the federal estate tax, imposing a 35% tax rate on estates that exceed the $5 million exemption through 2012. By taking specific steps, married couples may be able to pool their exemptions to shield up to $10 million. But these parameters — the most generous in decades — are temporary. After 2012, the federal estate tax is scheduled to revert to pre-2001 tax law levels, with a 55 percent top tax rate on estates valued at more than $1 million, unless lawmakers extend or modify the current law.

In addition to the federal estate tax, many states tax inheritances. Twenty-two states and the District of Columbia have estate or inheritance taxes that could apply to estate assets that are considerably lower than $5 million.2

A Matter of Trusts

If you are concerned that your estate may be subject to estate taxes, you might consider setting up a trust. When properly structured, an irrevocable trust may help you reduce or avoid the fees and estate taxes that may be imposed upon your death, control the distribution of your assets, and avoid probate. Trust assets are also protected from creditors.

A trust is a separate legal entity under which the grantor (or trustor) places assets in the trust, and a trustee administers the trust and eventually distributes assets to the beneficiaries according to the terms of the trust. Once property is placed in an irrevocable trust (which cannot be modified or terminated once set up), the assets are removed from the grantor’s taxable estate. Essentially, the grantor relinquishes ownership of the assets to the trust.

Irrevocable trusts can be used for specific purposes, such as to keep life insurance proceeds out of the taxable estate for the trust beneficiaries, and to benefit charitable groups.

An irrevocable life insurance trust can be used to replace assets in an estate left to charity (so beneficiaries will still receive an inheritance) and/or to keep life insurance proceeds out of the taxable estate. The grantor works with an attorney to set up the trust document, and the trustee uses money funded by the grantor to purchase a life insurance policy that is owned and controlled by the trust. When the insured individual dies, the life insurance proceeds are paid to the trust and distributed to the beneficiaries according to the terms of the trust. With this type of trust, the grantor cannot serve as the trustee, and the life insurance premiums must be paid by the trust.

The cost and availability of life insurance depend on factors such as age, health, and the type and amount of insurance purchased. Before implementing a strategy involving life insurance, it would be prudent to make sure that you are insurable.

With a charitable remainder trust, you transfer assets to the trust and name a charitable group as the eventual beneficiary. This strategy preserves the appreciated value of the assets placed in the trust because they

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won’t be subject to capital gains tax. The assets are typically sold by the charitable group and placed in an investment portfolio that can provide you (or your designated income beneficiaries) with a specified income that can last for your lifetime or a specific period of time; this income is generally taxable. Upon your death (or the death of your designated income beneficiaries), the charitable organization receives the “remainder” assets. By gifting the assets to a charitable trust, you can preserve the full value of your gift to charity.

A charitable lead trust offers a way to donate income from your gift while retaining ownership of the assets. The grantor places assets into an irrevocable trust on behalf of a designated charitable organization, and any income generated from those assets goes to the charitable group for the duration of the trust period. Upon termination of the trust, the remaining assets pass to the grantor or to the chosen beneficiaries. This could help reduce, or in some cases even eliminate, estate taxes on appreciated assets that eventually go to the grantor’s heirs.

You should bear in mind that not all charitable organizations are able to use every possible gift, so it would be prudent to check first. The type of organization you select can also affect any tax benefits you might receive.

A properly structured trust may help shield your assets from estate taxes, but you must relinquish ownership of them to the trust. The use of trusts involves a complex web of tax rules and regulations. You should consider the counsel of an experienced estate planning professional and your legal and tax advisors before implementing such strategies.

1) Tax Foundation, 2009
2) American Family Business Foundation, 2011

The information in this article is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Emerald. © 2011 Emerald Connect, Inc.