Chapter 10 Reducing Federal Estate Taxes

• Library: Estate Planning Basics (Nolo) (2022 Ed.)

CHAPTER 10: Reducing Federal Estate Taxes

Making Gifts During Life

Using the Federal Gift Tax Exclusion

Gifts of Interests in a Family Business

Gifts of Life Insurance

Disclaimer Trusts

Tax-Saving Irrevocable Trusts

The QTIP Trust for Married Couples

Life Insurance Trusts

Charitable Remainder Trusts

Generation-Skipping Trusts

Disclaiming Gifts

What can you do to reduce federal estate taxes if you think your estate will be liable for them? Not as much as you might hope. Of course, for the extremely rich, high-priced experts do come up with ingenious, or twisted, ways to dodge taxes. For those who are merely wealthy, aside from making use of the estate tax exemptions and deductions discussed in Chapter 9, there are basically only a few ways to reduce estate tax: Make gifts during your life, use a disclaimer trust, or use an irrevocable trust. His chapter discusses these options.

Making Gifts During Life

Obviously, if you give away property while you live, that removes the value of that property from your taxable estate. Here we'll look at different types of gifts you may want to make.

Using the Federal Gift Tax Exclusion

As you know from the discussion in Chapter 9, you can make gifts worth up to $16,000 per person per calendar year free of gift tax. A couple can give $32,000 per year tax free to any person. Tax-exempt gift giving can remove large amounts of money from an estate. A gift-giving program can be particularly advantageous for wealthy folks who have several children, grandchildren, or other people they'd like to help.

You can also make tax-free gifts of any amount for:

• payments made for someone's educational or medical costs, and
• contributions to tax-exempt charities. If you're quite prosperous, you may want to look into what's called a "charitable remainder trust."

To learn more about reducing your estate by making these types of tax-free gifts, see "Gift Tax," in Chapter 9.

Gifts of Interests in a Family Business

Gifts of minority interests in a family business can, in the right circumstances, reduce estate taxes. This is because a minority interest can be valued, for gift tax purposes, at less than the value it would have if it were part of the majority interest.

EXAMPLE: Angela gives her daughter, Lucia, 10% of Angela's interest in her furniture company. At the time of the gift, the company is worth $1 million. The value put on Lucia's 10% share is not $100,000 but something significantly less, in the $60,000-$80,000 range, because of minority business discounts. (The accounting rules here are fuzzy, and a tax professional must be consulted.)

Though this method can be helpful for an existing business, it's unlikely to work if you try to create a business and place your major assets, such as your home, in it. Under IRS rules, a family business must serve a valid business purpose and cannot be designed solely or primarily to reduce estate taxes.

Some "experts" have touted one particular business form, called a "family limited partnership," as a wonderful device for eliminating estate taxes. There's nothing at all magical about this type of business. It cannot transmute nonbusiness assets into a valid family business.

SEE AN EXPERT

Reducing taxes on a family business. If you have a family business and believe your estate may be liable for estate tax, see a lawyer to learn your options for reducing the tax bite.

Gifts of Life Insurance

From an estate tax standpoint, it can be very desirable to give away life insurance during your life. If you own your life insurance policy at your death, the proceeds (death payment) are included in your taxable estate. If the policy has a large death benefit—say, hundreds of thousands of dollars or more—including that sum in your taxable estate can result in substantial federal estate taxes. But the proceeds will not be subject to tax if someone else owns the policy when you die.

CAUTION

Don't wait to make a gift of life insurance. Under IRS regulations, a gift of life insurance must be made at least three years before your death. The potential tax savings from making a gift of life insurance are so large that the IRS will not allow any "deathbed" gifts. Defining "last minute" to mean at least three years does seem a tad excessive, but it's pointless to quarrel with the tax folks over this one.

Gifts of life insurance are subject to gift tax. The worth of the gift is, basically, the current value of the policy. This will always be far less than the amount the policy will pay at your death. If the present value is less than $16,000, no gift tax will be assessed.

There are two ways you can transfer ownership of a...