Taxes

Estate Taxes, Death Taxes, and Inheritance Taxes are all names that have been given to the taxes the federal government and state government charges to transfer your wealth to someone else when you pass on. In the tax world they are referred to as "Transfer Taxes."

State Transfer Taxes on Death
Every state is different. Some states don't even have a transfer tax, but most still do. Historically most states that had a transfer tax on death had it linked to the federal tax structure. However, when federal laws changed many states saw a great decline in their transfer tax revenues. In response, most states have "decoupled" their transfer tax laws from the federal estate tax.

Appropriate Legal Trust Based planning allows an individual to be creative based on their circumstances and build in contingencies. For instance, language could be drafted so that if a person lived in a state with no transfer tax and then moved to a state with a high transfer tax (or the laws changed again in their own state), the trust language would be flexible enough to minimize taxes in either situation.

Federal Transfer Taxes
There are two types of Federal Transfer Taxes.

Gift Tax - The person who gives any gift that is too large may have to pay a Gift Tax
Estate Tax - If you die with too much money your estate may have to pay an Estate Tax

Legal Planning for transfer taxes is done by the use of credits, exclusions, and deductions. 

Estate Tax Planning for the Married Couple (The IRS Coupon)
The IRS has given everyone on earth a coupon to pay for taxes up to a certain point. The coupon amount is the "Applicable Credit Amount" from the table above. This coupon pays the taxes you owe.

The "Estate Tax Exemption Amount" is the value your estate can hold at your death that the coupon will cover. This is the figure that most people talk about.

If a couple does not get used when the first spouse dies, they have just decided to pay the IRS with cash when the second spouse dies. Friends of Advanced Legal Planning generally agree that they would rather pay taxes with a coupon then with cash.

The Way it Works - When the first Spouse dies their trust assets are divided into two trusts. We will call the trusts the Marital Trust and the Family Trust, but both trusts can be available to the Spouse if you wish. The difference is that the Family trust is going to be taxed and that tax is going to be paid with the coupon. After the tax is figured and paid on the Family Trust, those amounts can grow as much as you want and there will not be any further estate tax levied against them. The Marital Trust utilizes the unlimited marital deduction so that no tax will have to be paid at that time.

In spite of what you may think initially, it is not always wise to use the full coupon on the first spouse's death. There is a delicate interplay between federal and state transfer taxes that must be considered. But foremost, your goals and how best to achieve them with your estate size and asset structure must be considered. It is possible that other things such as Charitable Planning, Life Insurance Trusts, and Family Bank Trusts, should be considered. You also may need to consider more Advanced Legal Planning such as Annuitizing Your IRA.

Example - Mary and Bob have an 8 Million dollar estate when he dies. Bob has 5 Million and Mary has 3 Million. When Bob dies in 2008 he is able to place 2 Million in the Family Trust and the rest goes to Mary in the Marital Trust. Mary now has 6 Million. She is able to transfer 1 million to loved ones through structured gifting using a Family Bank Trust, or a Life Insurance Trust, and is able to give away another 2 million using Charitable Planning. When she dies in 2009, Mary is taxed on 3 Million dollars. However, her coupon covers up to $3.5 Million so there is no estate tax due.

Estate Tax Planning for an Individual, Surviving Spouse, or Couple With a Large Estate
If these techniques are used by a Couple, they can double the amount given away. They may also be used for the benefit of one's Spouse. (i.e. Family Bank Trust)

As can be seen in the example above. Mary was working hard to pass on her wealth before her death and was able to reduce her Federal Estate Taxes to zero. So why not just give it all away to your kids before you die?

If you give any more than $12,000 (the current "Exclusion Amount") to an individual in any given year you have to pay Gift Taxes. You have a Gift Tax Coupon just like your Estate Tax Coupon. (See the Chart Above) Here is the rub; for each dollar of your Gift Tax Credit Coupon that you use, your Estate Tax Credit Coupon is reduced by $1 as well. Sometimes it is best to use up some of those coupon dollars during life and sometimes it is not.

Well, how much could you give away anyway? How many loved ones do you have? Are they married? Do they have children? It can add up pretty quickly.

But you don't want to give your kids cash right now. You want to provide a lasting legacy. Maybe you want to leave some instructions on how the money should be used. Well that is why we put the money into trusts. (see Life Insurance Trusts, and Family Bank Trusts.)

If things are planned appropriately, not only will you transfer lots of money to them, but you will also be able to have the income taxes on any growth charged to you. That way the trusts you create for your loved ones can retain maximum value and you are able to further reduce your estate. In essence you give them the money to pay the taxes without it being considered a gift. This is called, "Tax Burning."

If this will not allow you to give enough away to eliminate your estate taxes, you may either pay the tax, use Charitable Planning techniques, or more Advanced Legal Planning may apply.