If you have relatively simple legacy goals, we are here for you, but we are also fully equipped to provide advanced estate planning guidance. The pursuit of estate tax efficiency is one reason why you may want to explore some complex legal instruments. Of course, most people are not exposed to the federal estate tax because there is a relatively high credit or exclusion. That being stated, here in the greater Austin area, there are many very successful people. If you are one of them, we can provide you with a viable wealth preservation solution.
To determine whether or not you are exposed to the federal death tax, you should first inventory the value of the estate that you will be passing along to your loved ones. At the time of this writing, the exclusion is right around $11 million. This is the amount that you can transfer before the estate tax would be applicable. It carries a 40 percent maximum rate.
The estate tax exclusion is now portable between spouses. This means that a surviving spouse would be able to use their own exclusion and the exclusion that was afforded to their deceased spouse. Using the current figure that is in place, a surviving spouse would have a total of approximately $22 million.
We should point out the fact that the federal estate tax is not applicable on asset transfers between spouses, assuming the people involved are American citizens. Now that the federal government is recognizing same-sex marriages, this applies to all legally married couples without regard to gender.
The exclusion is subject to change, and even under the existing parameters, there can be annual adjustments to account for inflation. This is why we are not using precise numbers. You should check the current state of affairs if you are interested in finding out the exact amount of the estate tax exclusion at any given time.
At this point, you may wonder why you should be concerned about advanced estate planning devices to transfer assets in a tax efficient manner. To get around the estate tax, you can simply give gifts to loved ones that would be inheriting them anyway, right? Unfortunately, this is not an option, because there is also the federal gift tax. The exclusion is a unified exclusion that covers large lifetime gifts that you give along with postmortem asset transfers.
Estate Tax Efficiency Strategies
Now that you understand the lay of the land, we can look at a few of the different types of legal devices that are used to obtain estate tax efficiency. First, there is an estate planning tool called a qualified personal residence trust or QPRT. Your home is probably one of your most valuable possessions, and you can reduce its taxable value for transfer purposes if you were to convey it into this type of trust.
The way that it works is you transfer the home into the trust, and you are then removing it from your estate for tax purposes. You name a beneficiary to inherit the trust after the term expires. Since you will be giving this beneficiary a gift, the gift tax is applicable. However, you establish an interim during which you remain in the house as usual. This is called the retained income period. The IRS takes the delayed transfer into account when they calculate the taxable value of the gift. No objective buyer would pay full price for a house they couldn’t take possession of for five or ten years. As a result, the taxable value of the gift will be far less than the true fair market value of the home.
The zeroed-out grantor retained annuity trust is another tax efficiency strategy. To implement this approach, you convey assets that you expect to appreciate into the GRAT, and you name a beneficiary.
As the grantor, you receive distributions from the trust throughout the duration of the term. The IRS accounts for anticipated appreciation using the Section 7520 rate or “hurdle rate,” which is 120 percent of the federal midterm rate. You arrange to receive the entirety of the taxable value of the trust in distributions during the term, in effect “zeroing it out.”
However, if the assets outperform the hurdle rate that was added, the remainder will not be zero at the end of the term. There will in fact be something left in the trust, and the beneficiary would assume ownership of this remainder free of taxation.
There are a number of other vehicles that can be utilized as part of an estate tax efficiency strategy, including family limited partnerships, generation-skipping trusts, and irrevocable life insurance trusts.
We Are Here to Help!
Estate tax exposure can necessitate the utilization of advanced estate planning techniques, and there are scenarios that can require specialized approaches. If you have questions, we have answers, and you can get them in person if you call us at 512-478-3800 to schedule an initial consultation.