Estate Taxes FAQ

The two types of death taxes to focus on are federal estate tax and state estate tax. The federal estate tax is a percentage of your net estate and comprised of all assets you own or control minus certain deductions. These deductions include administrative expenses like charitable donations or funeral and burial costs. The current estate tax looks at net assets valued at $12.9 million or greater.

Even if you believe federal estate taxes won’t affect you, determine whether you may be subject to state estate and inheritance taxes. You may also have a taxable estate in the future as your assets appreciate in value. A regular estate plan review with an estate planning attorney ensures changes in the tax laws are considered, along with shifts in your individual circumstances.

The total value of your assets is your taxable estate, including your home, other real estate, business interests, share of joint accounts, retirement accounts, and life insurance policies. Subtract liabilities and deductions such as funeral expenses paid out of the estate, debts owed at the time of your death, bequests to charities, and the value of assets passed on to your spouse (US citizen). The taxable portion of the estate is paid by the estate itself before distributing assets to beneficiaries.

The federal government allows every couples to give an unlimited amount of assets, either by gift or bequest, to their spouse without any federal gift or estate taxes. Married couples can delay the payment of estate taxes at the first spouse’s passing. At the surviving spouse’s death, all assets in the estate over the applicable exclusion amount will be included in their taxable estate. The unlimited marital deduction only applies to surviving spouses who are US citizens.

A Credit Shelter Trust (Bypass or A/B Trust) eliminates or reduces federal estate taxes and is typically used by married couples whose estate exceeds the federal estate tax exemption.

Even though the Unlimited Marital Deduction allows a married person to leave an unlimited amount of assets to their spouse, free of federal estate taxes and without using any of their estate tax exemption, it doesn’t eliminate estate taxes for those with substantial assets; it only delays them. If the second spouse dies with an estate worth more than the exemption amount, their estate may be taxed on the amount exceeding the exemption. Meanwhile, the estate tax credit for the first spouse was unused.

Rather than wasting the tax credit from the first spouse, an estate tax return is filed even if no taxes are due, and a Credit Shelter Trust is used to preserve both spouses’ exemptions. Upon the first spouse’s death, a Credit Shelter Trust creates a separate, Irrevocable Trust containing the deceased spouse’s share of the assets. The surviving spouse is the beneficiary, and any children are beneficiaries of the remaining assets. This Irrevocable Trust is funded with the first spouse’s exemption amount. Estate taxes will not apply to the first spouse’s death, but the Trust can take advantage of the first spouse’s estate tax credit. Special language in the Trust prevents the assets from becoming subject to federal estate taxation, even if the value exceeds the exemption amount when the surviving spouse dies.

Our homes are valuable assets and one of the most significant components of our taxable estate. A Qualified Personal Residence Trust (QPRT) lets you give away your house or vacation home at a reduced value, freeze its value for estate tax purposes, and still continue to live in it.

The title to your house is transferred to the QPRT (usually for the benefit of family), but you can live in the house for a specific number of years. If you continue to live throughout that time, the house (and any appreciation in its value during that time) goes to your children and beneficiaries without any additional estate or gift taxes. You may continue to live in the home and pay rent to your family or beneficiaries to keep the residence out of your estate. This further reduces the value of your taxable estate, though your family may need to pay increased taxes on the rental income. If you die before the end of the specified number of years, the full value of the home is included in your estate for estate tax purposes. You will be no worse off than had you not established a QPRT. In the meantime, it serves as excellent asset/creditor protection since the property is no longer in your name once the trust is established.

Life insurance proceeds are a countable part of your estate and subject to estate tax but received by your beneficiaries free of income taxes. Your family can lose over forty percent of the value to federal estate taxes. An Irrevocable Life Insurance Trust (ILIT) moves your life insurance death benefits outside your estate where they are not subject to estate taxes. An ILIT has many options. They can be structured to provide income to a surviving spouse, with the remainder going to your children from a previous marriage. You can also distribute a limited amount of the insurance proceeds over time.

A Family Limited Partnership (FLP) is a limited partnership among family members. It has general partners to control management and limited partners as passive investors. General partners have ongoing liability to the partnership, while limited partners have no liability beyond their capital contributions. Typically, the older generation family members form the partnership and contribute assets for a small, general partnership interest and a bigger, limited partnership interest. The limited partnership interests eventually transfer to their children or grandchildren while retaining the general partnership for management.

The FLP has many benefits:

• Older family members reduce their taxable estate by transferring limited partnership interests to family members and maintaining control over the decisions and distributions of the investment.
• Limited partners can’t control investments or distributions, which makes them eligible for valuation discounts when assets are transferred and reduces the value of their holdings for gift and estate tax purposes.
• An FLP can have creditor protection characteristics since the general partners are not obligated to distribute the partnership’s earnings.