net estate

What are some methods of reducing a person's net estate so as to limit federal estate taxes?

Depending on its value, an individual's estate may be subject to a federal tax before any distributions are made to the heirs. In 2008 an individual could pass $2,000,000 to anyone estate-tax-free. This figure, sometimes referred to as the “applicable exclusion amount" or “unified credit amount," is scheduled to increase to $3,500,000 in 2009. Once an individual's assets exceed the “applicable exclusion amount," the balance is subject to the estate tax

An individual can reduce the amount subject to the estate tax through deductions, debts, and estate administration expenses. Deductions can be particularly useful in reducing the amount of estate tax owed. Two deductions—the estate tax charitable deduction and the estate tax marital deduction—are unlimited in scope. This means that an individual can give an unlimited amount of assets to a qualified charity or to a surviving spouse with no estate tax consequences. Thus, in 2008 an individual with a hypothetical $10,000,000 estate could give $2,000,000 to his children and the balance to his wife or a charity and pay no estate taxes at all. Assume that our individual was not charitably inclined and had no interest in benefiting any charities at his death. If he passed all of his assets in excess of the “applicable exclusion amount" to his wife, she would inherit $8,000,000 estate-tax-free. When she died, however, she would only be able to pass $2,000,000 to the children estate-tax-free, leaving $6,000,000 subject to the estate tax. Sophisticated estate planning generally involves giving assets away before death in order to reduce the estate taxes payable at death

Following are four of the methods most commonly used to reduce the amount of someone's net estate:

1. Annual gifting. An individual can give up to $12,000 annually to anyone he or she wishes. If used over time, this technique can reduce a person's net estate by thousands of dollars.

2. Irrevocable Life Insurance Trust. This trust usually benefits an individual's spouse and children after the individual dies. The trust enables the individual to transfer life insurance policies out of his or her name for estate tax purposes.

3. Qualified Personal Residence Trust (QPRT). This trust is used to transfer the ownership of one or more of an individual's residences to a named beneficiary. After a stated number of years, the individual must pay rent to the beneficiary in order to continue to live in the home; however, the value of the home is not included in his or her estate at death.

4. Limited Liability Company/Family Limited Partnership (LLC/FLP). These entities are often used to take advantage of discounting when giving assets away. Instead of receiving some or all of an asset outright, a donee receives an interest in an LLC or FLP. Because such interests are not marketable, they lack controlling interest, and they often represent a minority interest, their value is discounted, or adjusted downward to compensate. Discounts of between 25% and 40% for LLC and FLP interests are not uncommon.

Paul G. Holland, Jr., JD, LLM, Director, Wealth Planning, MiddleCove Capital, Centerbrook, CT