Estate Planning Ideas & Explanations

1. What happens if I die without a will?

All states provide for intestacy, which is the legal term for dying without a will. In essence, since you did not devise a plan for the distribution of your assets, the state law where you live controls the distribution of your assets, whether your assets total 1 dollar or 100 million dollars. For some, the results may be desirable, for many, they can border on disaster: Find out who will receive your estate.

For most people with assets in excess of $650,000 (especially if you are married), dying without a will is the equivalent of giving your money to the government. Although $650,000 is the federal exemption, most states have a separate estate tax. In New York, the applicable amount is only $300,000.

More importantly, your will generally provides a guardian for your minor children. Follow this link to see whom will inherit your estate.

2. Who has to pay estate taxes?

Depending on the value of your estate when you die, your estate may have to pay estate taxes before your assets can be fully distributed. Estate taxes are different from probate expenses (which can be avoided with a revocable living trust.

Federal estate taxes start at 37% and rise to 55%. Federal estate taxes must be paid within nine months after you die. Since few estates have this kind of cash, assets may have to be liquidated to pay the estate tax. However, estate taxes can be substantially reduced or even eliminated--if you plan ahead. Free Estate Tax Analysis and Estate Tax Calculator

Your estate will have to pay estate taxes if its net value on the date of your death is more than the "exempt" amount set by Congress at that time. Here is the current schedule:

3. What is my "net estate" ?

To determine the net value of your estate, use the current fair market value for all of the following: add all of your assets, then subtract your debts. Include all real property, business interests, stock interests, bank accounts, personal property, IRAs and other retirement plans, and death benefits from your life insurance.

4. What happens when a husband and wife own all of their assets jointly - the $270,000 mistake.

When an asset is held jointly, (Husband and Wife), the asset automatically passes to the Husband upon his wife's death. Thus, even if Wife's will leaves the asset to another family member, the asset will go Husband, as the asset was held jointly. Thus, a tax of an additional 267,000 may result if a husband and wife own all of their assets jointly and do not fully utilize both exemptions,

If your spouse is a U.S. citizen, you can leave him or her an unlimited amount when you die with no estate tax. But this can be a tax trap, because it wastes an exemption.

Let's say, for example, that Harry and Wilma together have a net estate of $1.35 million and they both die in 2000. Harry dies first. He leaves everything to Wilma, so no estate taxes are due then. When Wilma dies, her estate of $1.35 million uses her $675,000 exemption. The estate tax owed on the $675,000 would be $270,500.

But if, instead, Harry and Wilma plan ahead, they can use both their exemptions and pay no estate taxes. A tax-planning provision in their living trust splits their $1.35 million estate into two trusts of $675,000 each. When Harry dies, his trust uses his $675,000 exemption. When Wilma dies, her trust uses her $675,000 exemption. This reduces their taxable estate to $0, so the full $1.35 million can go to their loved ones.

However, there is a common pitfall that I have personally witnessed which could have been avoided with a few hours.

Assume Harry and Wilma had one child and assets in excess of 2 million dollars. All of the bank and stock accounts were held as Joint Tenants (Harry or Wilma). When Wilma passed away, all of her assets AUTOMATICALLY went to beloved Harry. Even though she had a provision in her will leaving her son $675,000, Wilma did not have the power to give her son any money because all of her assets were held as Joint Tenants with her husband. Thus, all of her assets passed by operation of law to her Harry. Although there was no tax because of the marital deduction, all of the assets were included in the Harrys estate when he died a few years later.

After all was said and done, the combined estates of the Harry and Wilma paid close to $300,000 in additional Federal and State estate taxes.

This could have been avoided by simply ensuring the Wilma had $675,000 in her own name, not as joint tenants with Harry or in trust for Harry.

5. Making Gifts

It seems as though everyone knows that each year a person can give up to $10,000 ($20,000 if married) to as many people as you wish. So if you give $10,000 to each of your two children and five grandchildren, you will reduce your estate by $70,000 (7 x $10,000) a year - $140,000 if your spouse joins you. (Beginning in 1999, this amount will be adjusted for inflation.)

You can give more than $10,000 to an individual, but it will use up some of your estate tax exemption. That's because it's a combined gift and estate tax exemption. While you're living, it's a gift tax exemption; after you die, it's an estate tax exemption.

When considering making gifts, a Family Limited Partnership (FLP) is the best vehicle. It essentially allows a person to give a non-taxable gift of $12,000 - $15,000 per individual ($24,000 - $30,000 if married) and allows the grantor to retain almost full control over the assets. If it seems almost too good to be trust, it isn't. A FLP is a great vehicle to reduce estate taxes and retain control over your assets.

6. Tax Consequences of Gifts?

As discussed in above, an estate tax is paid or your exemption is reduced by any gift in excess of $10,000 ($20,000 if married) per year.

However, assets you give away keep your cost basis (what you paid). If cash is given, the cost basis is equal to the fair market value but the same is not true for any other asset.

For assets other than cash, the recipient takes your cost basis, so the recipients may have to pay capital gains tax when they sell.

For example, if Harry gives to Sam, his son, Microsoft stock that he purchased for $1,000 that is now worth $100,000, the following tax consequences result.

1. Harry has made a taxable gift of $90,000 ($100,000 - $10,000). If both Harry and Sam are married, only $60,000 is taxable.

2. Sam has a cost basis of only $1,000 in the stock. Thus, if Sam sells the stock, he will have a long term capital gain of $50,000 - $80,000, depending on the marital status of both Harry and Sam.

It should be noted that once a gift is made, it is irrevocable (A revocable gift does not qualify for the $10,000 exemption and the asset is still included in the donor's estate). For this reason, a Family Limited Partnership is desirable. Although the gift is not revocable, the grantor can still exercise control over the asset.

7. Family Limited Partnership (FLP)

Any asset can be contributed to the partnership, such as stocks, bonds, shares of an existing family business and real estate.

For example, you and your spouse can set up a FLP and transfer assets to it. In exchange, you receive partnership shares. You keep the general partner shares and gift limited partner shares to your children, removing up to 99% of the value of the assets from your estate.

As general partner, you have full control. Limited partners (your children) have none. Their shares cannot be sold or transferred without your approval. And because there is no market for these shares, their value is highly discounted. So you transfer the assets to your children at a reduced value--with no loss of control.

Since the shares are discounted, you can effectively transfer more than $10,000 per year per individual.

For example, assume Harry has one son, Sam, and stock worth $100,000. Without an FLP, Harry can only give Sam 10,000 per year of the stock. Harry also retains no control over the stock.

If Harry transferred the stock to an FLP, Harry can likely give a tax-free gift of a 13% limited partnership interest. Although a 13% partnership interest is technically worth $13,000 ($100,000 * 13%), the partnership interest is discounted as Sam has very limited rights with respect to his partnership interest.

Over a period of time, the results of a FLP can effectively deplete your entire estate while you retain FULL control over the assets.

For a more detailed discussion, see Family Limited Partnerships

8. Irrevocable Life Insurance Trusts (ILIT)

Almost every life insurance policy should be owned by a life insurance trust. Any asset that you own is included in your estate, including life insurance. A life insurance trust can be used to avoid the taxability of life insurance proceeds. If you pay the life insurance premiums from your own checking account, it is highly likely that you own the policy and the proceeds will be included in your estate, even if the proceeds are not payable to your estate.

Simply create a trust, which will own the life insurance policy. Each year, you contribute an amount equal to the insurance policy and the trust pays the premiums. When you eventually die, the proceeds are remitted to the trust, not your estate. Thus, there is no estate tax on the proceeds.

For a more detailed discussion, see Life Insurance Trusts.

A common pitfall is where an existing policy is transferred to an ILIT. As long as you live three years after the transfer, the death benefits will not be in your estate. However, if you pass away within three years of transferring the policy, the proceeds are included in your estate.

9. Qualified Personal Residence Trust (QPRT)

A QPRT allows you to remove your home from your estate now while you continue to live there.
Basically, you transfer your home to a trust for a period of time, usually between 10 to 15 years. During this time period, you may continue to live in your home. After the selected time period expires, your home is then transferred to the trust beneficiaries, usually your children or grandchildren. If you wish to stay there longer, you may make arrangements to pay rent to the trust beneficiaries - which further reduces your net estate. However, if you die before the trust ends, your home will be included in your estate as if you did not create a QPRT.

A QPRT leverages your estate tax exemption. As your children will not receive the house for 10-15 years, the value of the home is discounted. For example, if the current value of your home is $300,000 and you put it in a QPRT for 15 years, its value for tax purposes could be as little as $90,000.

It should also be kept in mind that you can sell your personal residence and exclude up to $250,000 of gain ($500,000 if married). Many people are using the proceeds to purchase a smaller residence and contributing the proceeds to a Family Limited Partnership, which is becoming, or has already become, the preferred vehicle to remove assets from an estate.

• Visit our Acclaimed Estate Planning Education Page
• Intestacy - who will receive your property if you do not have a will
• Free Estate Tax Analysis
• Estate Tax Calculator - how much tax will your estate pay?
• How to Get Started
• Health Care Proxy
• Estate glossary