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As always, it is our pleasure to bring you the latest news about estate and wealth preservation planning. Below you will find an informative article outlining sophisticated estate planning techniques. Also, Greg Bloshinsky returns with an answer to a reader's question about the differences between the estate tax threshold and the gift tax threshold.

Once your basic estate plan is in place (Revocable Trust, Last Will and Testament, Durable Power of Attorney, Health Care Surrogate and Living Will), sophisticated planning comes next. Knowing that you have the most appropriate plan in place for you and your loved ones will give you peace of mind. A simple overview of some sophisticated planning techniques follow:

Gifting
The first method of reducing the taxable estate is to make lifetime exempt gifts. Under present law, gifts between spouses, who are U.S. citizens, during life or after death, are unlimited. Gifts to any donee may be exempt up to $12,000, or if the spouse consents that the gift may be considered one-half from him or her, the exempt gift may be doubled to $24,000. Gifts to qualified charities can reduce the taxable estate and lifetime gifts and provide the added benefit of an income tax deduction. Payments made directly to educational institutions and health care providers are unlimited and exempt.

Irrevocable Life Insurance Trusts
If estate taxes are anticipated, the use of an Irrevocable Life Insurance Trust is a common method of meeting the tax burden. This is a separate irrevocable trust sometimes referred to as an "ILIT" and is funded by annual exempt gifting of premiums to beneficiaries, employing "crummy powers" to convert deferred gifts into present interest gifts used to purchase life insurance policies. This type of trust, if properly drafted and funded, is not subject to estate tax, and provides funds to pay anticipated estate taxes with leveraged dollars. The use of a "second to die" type policy, which pays out at the death of the survivor of grantors, if there are more than one grantor, substantially reduces the policy premiums.

Trusts for Minors
Gifts to grandchildren and other minor beneficiaries for college education and other needs may be funded by the use of a trust. The trust is funded by gifts of the annual exclusion amount. This provides a method of safeguarding the gifts from the minors spending until age 21 years and may be extended to age 25 years with suitable provisions. Other gift trusts for grandchildren and more remote descendants can also be established.

Family Limited Partnership
The Family Limited Partnership (FLP) is a well established estate planning tool. The family wealth can be transferred into the FLP by the original partners. Annual exempt gifts of partnership interests can be made at a discount to beneficiaries. Creditor protection is afforded as in other limited partnerships. The entity could be controlled by the general partner which can be funded with as little as 1% of the total assets.

Limited Liability Company
The Limited Liability Company (LLC) can also be an effective tool for estate planning. The owners of an LLC are called "members" and the owners may consist of individuals, aliens, partnerships, trusts, corporations, and other legal entities. The ownership rights may be used to fund gifts in the same manner as outlined above for an FLP. In Florida, an LLC allows pass through treatment of income to members such as is allowed in S corporations and partnerships. The LLC offers: excellent liability protection; no limitation on the number of members; full participation of owners in management; simplicity in taking profits out without double taxation; no citizenship requirement for members; treatment of a member's personal creditor as an assignee, with no forced sale or dissolution of the company; and indemnification of members for any judgment, debt, or obligation of the LLC.

Charitable Remainder Unitrust
The Charitable Remainder Unitrust (CRUT) is an excellent planning tool to reduce the taxable estate with many advantages. The CRUT offers: an opportunity to benefit charity(s) of your choice; avoidance of capital gains tax on highly appreciated assets; increase of your annual income; a current charitable deduction for income tax; and, reduction of your estate tax exposure to zero. The trust is open ended and additional contributions can be added. If the trust is properly structured, the grantor(s) do not part with the principal of the trust until death of the grantor(s) or a minimum period of years. Since the trust is tax exempt, the trustees can sell the assets, reinvest the sale proceeds and bypass capital gains tax. As long as the assets are invested in publicly traded securities and there is no self-dealing, the grantor of the trust can also serve as trustee.

Charitable Lead Trust
A Charitable Lead Trust created during the life of the donor(s) results in a gift tax charitable deduction for the present value of the income distributed to qualified charities. Similarly, a "Testamentary Lead Trust" receives an estate tax deduction equivalent to the present value of the income stream distributed to a qualified charity.

This article only covers a small spectrum of sophisticated estate planning techniques which help in probate and tax avoidance and there may be other techniques more suitable for a particular client.

Question
Dear Mr. Bloshinsky,

What is the difference between the estate tax threshold and the gift tax threshold and how is my federal gift tax liability determined?

Sincerely,
Confused

Answer
Dear Confused,

First, let's distinguish between the estate tax exemption and gift tax credit. In 2007 and 2008, the first $2 million of your taxable estate is exempt from federal estate tax. (Technically, the law provides for this exemption by allowing a credit of $780,800, which is the amount of tax on the first $2 million of a taxable estate, calculated under the estate tax rate schedule.) Your spouse is also entitled to an exemption of $2 million. In 2009, the exemption equivalent for estate tax purposes will be $3.5 million. The estate tax is scheduled to expire on January 1, 2010, but it is scheduled to be restored (with only a $1 million exemption) on January 1, 2011. On the other hand, the gift tax credit is only $1 million.

Now that this distinction between the estate tax exemption and the gift tax credit is clear, it should be noted that the gift tax rate is based on the cumulative amounts of taxable gifts you make over the course of your life. Thus, as you make more and more taxable gifts, your gift tax bracket increases.

First, because of the annual exclusion, only gifts in excess of $12,000 to each donee are "taxable" in 2007.

Next, the gift tax on the first $1 million of taxable gifts you make during your life is covered by a gift tax credit. This credit wipes out the first $345,800 of gift tax liability. This is the liability that would arise from $1 million of taxable gifts. Accordingly, only after the taxable gifts you make during your life reach $1 million will any gift tax apply. The tax on gifts made in the current year is the tax on total lifetime gifts minus the tax on gifts made before the current year.

Example. The taxpayer made no taxable gifts before 2001. In 2001, the taxpayer made $750,000 in potentially taxable gifts. The gift tax liability on this amount, calculated under the gift tax rate schedule, was $248,300, but the credit of $220,550 that was in effect in 2001 (exempting the first $675,000 of gifts) reduced the actual tax bill to $27,750.

In 2007, the taxpayer makes an additional $250,000 in potentially taxable gifts. This brings lifetime gifts up to $1 million. Before application of the gift tax credit, the gift tax on $1 million of gifts would be $345,800: a $248,300 gift tax liability on the 2001 gifts, plus $97,500 on the 2007 gift of $250,000, taxed at a marginal bracket of 39%. The actual 2007 gift tax bill is zero, because the gift tax credit of $345,800 that applies in 2007 effectively exempts $1 million of gifts. Because the taxpayer has used up his lifetime gift exemption, any otherwise taxable gifts he makes in later years will not be exempted from tax by the gift tax credit.

As discussed above, under federal tax legislation enacted in 2001, the estate tax is repealed, effective 2010. However, the gift tax was not repealed. Therefore, the gift tax promises to remain a powerful consideration in the structuring of lifetime dispositions and in estate planning.

It is also important to remember that a gift tax return should be filed by April 15th of each year following the year gifts are made in excess of your annual exclusion.

If you would like to discuss the role lifetime gifts can play in your overall estate plan or have any additional questions, please call 561-750-3850.

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This publication is intended for general information purposes only. It is not intended to constitute individual legal advice to any specific client.