The bad news is that the Estate Tax, or "Death Tax," is a confiscatory tax on inheritance with rates as high as 55%. The good news is that everyone is entitled to an exemption from the Estate Tax. Over the last decade, the exemption has rapidly risen from $675,000 in 2001 to $3.5 million in 2009. As a result of these rules, most clients over the last decade have not had to do more than Basic Estate Planning such as setting up an A/B Trust. However, beginning in 2011, many clients may have to engage in Advanced Estate Planning, once only reserved for extremely wealthy individuals.
Currently in 2010, there is no Estate Tax. However, in 2011, the Estate Tax comes back and the Estate Tax Exemption is scheduled to drop to $1 million. This means that if you add up the fair market value of everything you own, any amount over $1 million will be subject to a 55% Estate Tax. Advanced Estate Planning may be the answer.
One Advanced Estate Planning technique is to make annual gifts to relatives. Each person may gift up to $13,000 per person per year without any Gift Tax or Estate Tax ramifications. Many clients make it an annual habit to gift $13,000 to children, grandchildren, and other loved ones. Some clients take it a step further by forming Family Limited Partnerships or Family LLC's and giving away fractional interests in such entities. By doing so, they can take advantage of "fractional discounts" – the principal that a minority interest in an entity is worth something less than the proportional fair market value of the interest since there is no control over the entity. This technique allows you to give more away at a lower Gift Tax "cost."
Another Advanced technique is to gift an asset that is expected to appreciate. If you give away more than $13,000 to a single person in a single year, you start using up your Estate Tax Exemption. However, if you think a particular asset will dramatically appreciate in value in the future, you may want to gift that asset now, while the value is low, and allow the appreciation to occur in your beneficiary's Estate rather than in your Estate. This technique is known as an "Estate Freeze."
A sophisticated "Estate Freeze" technique is a special kind of irrevocable trust known as a Qualified Personal Residence Trust, or a "QPRT" (pronounced “cue-pert”). Our homes are often our most valuable assets and hence one of the largest components of our taxable estate. A QPRT allows you to give away your house or vacation home at a great discount, freeze its value for estate tax purposes, and still continue to live in it. Here is how it works: You transfer the title to your house to the QPRT (usually for the benefit of your family members), reserving the right to live in the house for a specified number of years. If you live to the end of the specified period, the house (as well as any appreciation in its value since the transfer) passes to your children or other beneficiaries free of any additional estate or gift taxes. After the end of the specified period, you may continue to live in the home but you must pay rent to your family or designated beneficiary in order to avoid inclusion of the residence in your estate. This may be an added benefit as it serves to further reduce the value of your taxable estate, though the rent income does have income tax consequences for your family. If you die before the end of the period, the full value of the house will be included in your estate for estate tax purposes, though in most cases you are no worse off than you would have been had you not established a QPRT. An added benefit of the QPRT is that it also serves as an excellent asset/creditor protection vehicle since you no longer technically own the property once the trust is established and your residence is transferred to the QPRT.
In addition, there are other Advanced techniques that may be worth discussing with an attorney in anticipation of the scheduled 2011 Estate Tax Exemption.