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Estate Tax Planning

If you have accumulated significant assets during your lifetime, advanced tax planning can help transfer your assets to younger generations while minimizing your income and estate taxes. The federal estate tax imposes a tax of 40% on all assets in an estate in excess of $5.49 million (2017). Therefore, if everything you own is worth more than $5 million – or is likely to be worth more than $5 million in the future – you may benefit from estate tax planning.

The federal estate tax is coordinated with the federal gift tax, such that the amount subject to tax is based on the combined value of assets that (1) you give away during your life and (2) are transferred to your heirs as part of your estate. The tax is levied only on amounts exceeding a certain threshold level, which for 2014 is $5.49 million. This means that you have can give away $5.49 million dollars either during your lifetime or at death without incurring any estate taxes. The tax only kicks in for amounts in excess of the $5.49 million.

There are a number of strategies that can help you to reduce - or in some cases eliminate - the estate tax. Below some estate planning strategies that we use to minimize estate tax liability.

Life Insurance Trusts

Irrevocable Life Insurance Trusts are one of the most common strategies for minimizing estate taxes.

Life insurance can be an excellent way to provide for your family if something happens to you, but few people realize that life insurance is included in the value of your estate for estate tax purposes.  So, even if your net worth is $4 million, your family could end up paying estate taxes if you have a $2 million life insurance policy.  

By purchasing the insurance policy through a trust or transferring an existing policy to a trust, you can remove the policy from your estate for estate tax purposes. 

Grantor Retained Annuity Trusts (GRATs)

A Grantor Retained Annuity Trust (GRAT) is a planning technique that allows you to transfer property to your heirs in exchange for income paid to you over a certain term based on 120% of the Applicable Federal Rate (AFR) then in effect. While this technique does not entirely “freeze” your estate, it reduces any increase in the value of your estate to the applicable interest rate. The recent historically low interest rates have made GRATs a popular tool for transferring appreciation of an asset free of estate and gift tax because of the likelihood that, over a long period of time, the value of most assets will grow faster than the applicable interest rate.

GRATs were famously used by Mark Zuckerberg, the founder of Facebook, who transferred about 3.5 million shares of Facebook into a trust in 2008, in exchange for an annuity based on the then fair market value of the shares – about 83 cents per share at that time. In 2012, Facebook shares were valued at over $30 per share in an initial public offering. By using the GRAT, it is estimated that Zuckerberg was able to transfer over $37 million to his heirs free of any gift or estate tax. His cofounder, Dustin Moskovitz, transferred almost $150 million!

Of course, few people are in the position of Mark Zuckerberg. But in today’s low interest rate environment, anyone who is concerned about estate taxes may want to consider using a GRAT. The long-term AFR (9+ years) has recently been well under 3%, while the historic long-term performance of equities is 8-12%. By using a GRAT, any appreciation over 3% can be transferred to your heirs clear of any estate or gift tax, and there is no depletion of the gift and estate tax exemption.

Qualified Personal Residence Trusts (QPRTs)

A person’s most valuable asset is often their principal residence or vacation home. A common technique for transferring your home to your heirs while avoiding estate tax is the qualified personal residence trust (QPRT). To make use of the benefits of a QPRT, a person transfers their home to a trust while retaining the right to live in it for a specific term of years. The amount of the taxable gift to the beneficiaries is the value of the remainder interest in the home when the retained residence rights expire – a significant discount from its current value. When the term of the QPRT expires, the taxpayer can continue living in the home, but must pay rent to the beneficiaries of the trust.