The primary goal of estate planning should be to protect yourself and your family, and to ensure that your ultimate plans for the transfer of your wealth are achieved. Nevertheless, estate taxes are a major consideration, as they can devour a substantial portion of your accumulated wealth. Currently, estate taxes top out at 45%, and must be paid within nine months of the date of death. However, there are a number of estate planning strategies that can reduce or eliminate estate taxes for families with estates over $3.5 Million.

1.The Federal Coupon

In 2009, each person is entitled to a $3.5 million dollar exemption from the Federal Estate Tax. This is called the “Federal Estate Tax Applicable Exclusion Amount”. I refer to it as your Federal Coupon. If you die in 2009 with less than $3.5 million dollars, and you made no taxable lifetime gifts, no estate tax will be owed by your estate.

In 2010, estate taxes will be repealed for exactly one year (but a capital gains basis system will be in effect for the year 2010). So you can die in 2010 with any size estate and owe no estate taxes (but your estate will likely have to pay capital gains tax instead). However, in 2011 the federal estate tax will be reinstated with a Federal Coupon amount of $1 million per person. Because of the uncertainty in knowing what the Federal Estate Tax will be when you die, or what changes to the tax laws may be made in the future, we recommend estate tax reduction strategies for any clients with currently at least $3.5 million in their estates.

2. The Credit Shelter Trust

A Credit Shelter Trust (also commonly known as a “B” or “Bypass” Trust) is a trust created within your revocable trust at the death of the first spouse. This allows a husband and wife to effectively double the amount they can give tax free to their children. If drafted correctly, this trust can:

• Shelter trust assets from federal estate taxes

• Provide the surviving spouse substantial access to trust income and principal for the remainder of his or her life

• Protect substantial sums from creditors and predators who may prey on a surviving Spouse

• Seamlessly transfer assets to children or other beneficiaries when the surviving spouse dies

• Keep trust assets out of the surviving spouse’s estate

3. Annual Gifts And The Family Bank Trust

If your estate exceeds the amount of the Federal Estate Tax exemption, one way to reduce the size of your estate and avoid estate taxes is to make gifts to your family members while you are still alive. As long as these gifts do not exceed the annual exclusion amount, which is currently $13,000 per recipient per year, you will not have to file a gift tax return on the gifts. This means that you can give away up to $13,000 to each of your children and/or grandchildren each year without any gift tax consequences.

A lifetime gifting program allows you to avoid gift, estate and generation-skipping transfer tax on transferred assets. Under the Internal Revenue Code, you can transfer up to $13,000 per year, per person, to anyone without incurring gift tax or the generation- skipping transfer tax. With a lifetime giving program, you can transfer this amount annually to the individuals of your choice, typically children, grandchildren and other close family members.

For example, if you give $13,000 per year to two beneficiaries for five years, you will have removed $130,000 from your estate for estate tax purposes. After 10 years, you will have removed more than $260,000 and nearly $650,000 after 25 years. We have many clients who would like to make annual gifts, but who don’t want to lose control of the assets that they give away. For these clients, we recommend the Family Bank Trust. A Family Bank Trust is a type of irrevocable trust that provides complete asset protection for your spouse, children and/or grandchildren. It also removes the trust assets from your estate and the estates of your spouse, children and/or grandchildren for estate tax  purposes. This type of trust is very similar to a “bypass” trust (one that bypasses the Federal Estate Tax) at death. You don’t lose access to the assets because your spouse can withdraw from the trust for health, education, maintenance or support.

Annual exclusion gifts are used to shield transfers to the Family Bank Trust from gift and generation-skipping transfer taxes. The beneficiary must have the right to withdraw up to $13,000 of the transferred funds, but if that right is not exercised, the gifted funds can then be used to purchase life insurance on the life of the transferor or for other investments. This trust can be a multigenerational estate tax exempt trust or it can become a family “bank” for:
(1) education;
(2) business acquisitions; or
(3) home purchases,
among other things. With a Family Bank Trust, you irrevocably transfer assets to the trust of which your spouse is trustee (or co-trustee) and beneficiary. Your children and other descendants can also be beneficiaries during your spouse’s lifetime, or they can be remainder beneficiaries after the death of your spouse. A married couple can create similar trusts for each other’s benefit, and thereby obtain the asset protection and estate tax benefits, but the trusts cannot be identical in all respects. This gives each spouse access to the assets in the other spouse’s trust.

In addition to annual exclusion gifts, medical care and tuition paid to assist family members or any other individual may be made free of gift tax. As long as the gifts are made directly to the medical facility or educational institution, donors can exceed the $13,000 annual exclusion amount without imposition of gift taxes.

4. Life Insurance and The Wealth Replacement Trust (aka Irrevocable Life Insurance Trust)

Life insurance is a unique asset in that it serves numerous diverse functions in a tax favored environment. Life insurance proceeds are received income tax free and, if properly owned by an Irrevocable Life Insurance Trust, life insurance proceeds can
also be received free of estate tax. Some of the frequent uses for life insurance include:

a.) Wealth Creation: Where age or other circumstances have prevented one from accumulating a desired level of wealth, life insurance can create instant wealth, for example, to build an estate, to replace a key employee, to buy out the interest of a business co-owner at death, or to pay off a mortgage.

b.) Income Replacement: Life insurance can provide wealth to replace income lost upon the premature death of the family “bread winner.”

c.) Wealth Replacement: Life insurance can provide the liquidity to pay estate or capital gain taxes after death. Life insurance can also be used to replace the value of gifts to charity or non-family members.

There are several types of life insurance, including term, permanent, and survivorship or second-to-die insurance. Term insurance, which includes annual renewable and fixed-level term (for example, 20-year Level Term) is temporary. At the end of the term, the policy terminates and the insured must reapply at the then-going rates, based upon age, health, etc. Therefore, term insurance is often recommended for temporary needs.

Permanent insurance, of which there are several types- whole life, universal life, and variable universal life-- are intended to remain in force until the insured’s death, and thus are often recommended for permanent needs.

Survivorship or second-to-die insurance pays out at the death of the survivor. Therefore, second-die insurance is often recommended in those circumstances where the liquidity need arises only at the second death; for example, the need for liquidity to pay estate taxes or to care for minor children.

Contrary to what many people think, at death, the death roceeds of life insurance you own are included in your estate for estate tax purposes. This adverse result can be avoided by transferring the life insurance policy to an Irrevocable Life Insurance Trust (or having the trust purchase a new policy on your life) that would become the owner and beneficiary of the policy. The disposition terms of the trust would mirror the terms in your revocable living trust. However, note that it is much more favorable to have the Irrevocable Life Insurance Trust purchase a new policy on your life as opposed to transferring an existing policy to the trust. This is due to the IRS three-year look back rule that could pull the insurance proceeds back into your estate if you die less than three years after the transfer of an “existing” policy to your irrevocable life insurance trust. A properly drafted Irrevocable Life Insurance Trust (ILIT) can accomplish the following
objectives:

• Provide income and/or principal to your heirs
• Prevent life insurance proceeds from being included in your estate
• Provide your family with funds to pay estate tax and settlement expenses
• Provide your surviving spouse with access to the death benefit for his or her health, education, maintenance or support
• Protect the proceeds of the life insurance from creditors and predators
• Care for your minor children

If you are concerned about accessing the cash value of the insurance during your lifetime, the trust can be carefully drafted so that the trustee can make loans to you during your lifetime or so that the trustee can make distributions to your spouse during your spouse’s lifetime. Even with these provisions, the life insurance proceeds will not be included in your estate for estate tax purposes.

You can create these trusts individually (and typically own an individual policy on your life) or they can be created jointly by you and your spouse (with a survivorship policy).

5. Keep Your Family Home In The Family

A Qualified Personal Residence Trust (“QPRT”) is a type of trust specifically authorized by the Internal Revenue Code. It permits you to transfer ownership of your residence to your family during your lifetime and retain the exclusive right to live in the residence, while reducing the size of your estate for estate tax purposes.

The residence is transferred to the Qualified Personal Residence Trust for a designated initial term of years. Provided you survive the initial term of years, ownership of the residence will be transferred to your family at a fraction of its fair market value. If you die during the initial term of years, the property will be brought back into your estate, but you will be no worse off than had you not created the Qualified Personal Residence Trust. You may transfer up to two (2) personal residences into Qualified Personal Residence Trusts.

The Qualified Personal Residence Trust is a particularly noteworthy estate-planning tool to reduce federal estate taxes . It permits you to transfer a residence out of your taxable estate while retaining the right to use it during your lifetime. The gift for federal gift tax purposes is based upon IRS published interest rates at the time of the transfer, and this rate does not take into consideration actual appreciation in the value of the property. Accordingly, these trusts are particularly useful to transfer residences in which significant future appreciation is anticipated. The Qualified Personal Residence Trust permits you to continue to enjoy your residence, knowing that the value at the date of death will not be included in your estate.

During the term of years of the trust, you have the absolute right to remain in the residence rent free. After the initial term, you can be granted the right to rent the residence for the balance of your lifetime for its fair rental value. During the term of years, you can be the sole trustee or a co-trustee of the trust with complete control over all decisions of the trust and the assets in the trust. You may also sell the residence and buy another residence during the trust term.

Because the Qualified Personal Residence Trust is a “grantor trust” under the income tax laws, you are treated as the owner of the property for income tax purposes during the initial term of years. Therefore, all items of income, gain, loss and deduction with respect to the trust are treated on your personal income tax return. So for example, the deduction for real estate taxes remains available to you. In addition, favorable capital gains treatment, including capital gain rollover and the $250,000 individual exclusion of capital gain are still available to you. This strategy is particularly useful for a vacation home that you wish to keep in the family.

6. Charitable Contributions Are Good For Your Heart and Your Pocket Book

Gifts to charities are fully exempt from gift and estate taxes. In addition, they qualify for current income tax deductions. These lifetime gifts can reduce your estate by both the value of the gift and any subsequent appreciation. Various charitable trusts can be created which offer additional advantages. These trusts, Charitable Remainder Trusts and Charitable Lead Trusts, are discussed below.

Charitable Remainder Trust

The Charitable Remainder Trust (“CRT”) is a type of trust specifically authorized by the Internal Revenue Code. These irrevocable trusts permit you to transfer ownership of assets to the trust in exchange for an income stream to the person or persons of your choice (typically you). This can be for life or for a specified term of up to 20 years. With the most common type of Charitable Remainder Trust, at the end of the term, the balance of the trust property (the “remainder interest”) is transferred to a specified charity or charities. Charitable Remainder Trusts reduce estate taxes because you are transferring ownership to the trust of assets that otherwise would be counted for estate tax purposes.

A Charitable Remainder Trust can be set up as part of your revocable living trust planning, coming into existence at the time of your death, or as a stand-alone trust during your lifetime. At the time of creation of the CRT, you or your estate will be entitled to a charitable deduction in the amount of the current value of the gift that will eventually go to charity. If the income recipient is someone other than you or your spouse, there will be gift tax consequences to the transfer to the CRT.

Charitable Remainder Trusts are tax-exempt entities. In other words, when a Charitable Remainder Trust sells an asset, it pays no income tax on the gain in that asset. Therefore, after a sale, the trust has more available to invest than if the asset were sold outside of the Charitable Remainder Trust and subject to tax. Accordingly, Charitable Remainder Trusts are particularly suited for highly appreciated assets such as real estate and stock in a closely held business, or assets subject to income tax such as qualified plans and IRAs. While the Charitable Remainder Trust does not pay tax on the sale of its assets, the tax is not avoided altogether. The payments to the income recipient will be subject to income tax.

There are several types of Charitable Remainder Trusts. For example, the Charitable Remainder Annuity Trust pays a fixed dollar amount (for example, $80,000 per year) to the income recipient at least annually. Another type of CRT, the Charitable Remainder Unitrust, pays a fixed percentage of the value of the trust assets each year to the income recipient (for example, 8% of the value as of the preceding January 1). A third type, perhaps the most common, allows you to transfer non-income producing property to the CRT. This converts the trust to a Charitable Remainder Unitrust upon the sale or happening of a specified event (for example, upon reaching a specified retirement age).

At the end of the term of a Charitable Remainder Trust, the remainder interest passes to qualified charities as defined under the Internal Revenue Code. Generally, any charity that has received IRS tax-exempt status qualifies, but this is not always the case. It is possible for you to name a private foundation established by you as the charitable beneficiary.

Charitable Lead Trust

The Charitable Lead Trust is a type of charitable trust that can reduce or virtually eliminate all estate tax on wealth passing to heirs. In order to accomplish this goal, you create a trust that grants to a charity or charities, for a set number of years, the first or “lead” right to receive a payment from the trust. At the end of the term of years, your children or grandchildren receive the balance of the trust property—which of ten is greater than the amount contributed—free of estate tax in most instances.

Although the Charitable Lead Trust is a complex estate planning strategy, the steps to implement it are few and simple from your perspective. Here is how one of the most frequently used Charitable Lead Trusts, the Charitable Lead Annuity Trust, operates:

You, as grantors, create a Charitable Lead Trust as part of your revocable living trust planning. Upon the death of the survivor of the two of you, a substantial amount of property will pass to the Charitable Lead Trust. The income beneficiary of the Charitable Lead Trust will be a qualified charitable organization, chosen by the two of you or by the survivor of you, named in your revocable living trust. The charitable income beneficiary receives a fixed, guaranteed amount from the trust for a certain number of years (determined by you with the assistance of your legal and financial advisors). Generally, any charity that has received IRS tax exempt status qualifies, but this is not always the case.

It is also possible for you to name a private foundation established by you as the charitable beneficiary. If so, you must have very limited authority over which charity is to receive money from the foundation. Too much control while you are alive will result in adverse tax consequences. At the end of the Charitable Lead Trust’s term, the remaining assets in the trust pass to non-charitable trust beneficiaries such as children and grandchildren, free of estate and gift tax. These assets can pass outright to the beneficiaries, or can continue to be held in trust, either in new trusts or in trusts previously established for the benefit and protection of the beneficiaries.

The charity will receive the same dollar amount each year, no matter how its investments perform. The remainder interest ultimately passing to the heirs, however, will be affected by the performance of the trust’s investments.

Charitable Lead Annuity Trusts are particularly suited for hard-to-value assets (such as real estate or family limited liability company interests) and assets which are expected to grow rapidly in value.

About Brenda Geiger, J.D.

Brenda is a Trusts & Estates Attorney with her primary office located in Carlsbad, California (she also has satellite offices in Costa Mesa and La Jolla). Brenda graduated from the University of San Diego School of Law where she served as an Editor on the San Diego International Law Journal and published a scholarly article in the Law Journal. Brenda is also a published author of many articles and 3 books on estate planning. The most recent book was released in June of 2009 entitled “Safeguarding the Nest” available at www.SafeguardTheNest.com. Her passion is helping families protect their children and keeping families out of the court process at incapacity and death. On a more personal note, Brenda is married to Len, the CEO of the San Diego based web hosting company WebIntellects, Inc. and they have two small children, Lenny and Taylor. They also have two dogs, Starsky and Semper (their lovable German Shepherds).

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