Estate Planning 101

We thought it would be helpful if we briefly outlined some suggestions regarding estate planning which, if implemented, could result in substantial estate tax savings:

(1) A simple Will may cost your heirs substantial estate tax – especially New York State estate tax—

Even with the dramatic increase in the Federal estate tax exemption to $11 million* passed as part of the Tax Act of 2018, if you have a “simple” Will leaving all your assets to your spouse outright, your estate may be unnecessarily incurring estate taxes. The reason for this is that by simply leaving all of your assets to your spouse outright, you fail to take full advantage of both spouse’s Federal and New York State estate tax exemptions. By properly structuring your Wills to take advantage of each spouse’s exemption, you can accomplish a substantial estate tax savings for your beneficiaries.

Even if your estate is worth less than $11 million ($22 million per couple), you still need to have a properly structured estate plan to take full advantage of the New York State exemption which is only $5.25 million.  Without proper planning, your estates can unnecessarily incur New York State estate tax.

* The Federal exemption is scheduled to revert to the 2017 amount of $5.5 million on January 1, 2026.

(2) Life Insurance Trusts – The Last Tax Shelter —

Since the passage of the Tax Reform Act of 1986, there are few true tax shelters remaining. One such tax shelter that still remains is the life insurance trust. Generally, life insurance is taxable to the insured’s estate upon his or her death. This means that up to approximately 50% of the proceeds will be paid to the Internal Revenue Service in estate tax. By transferring the ownership of a life insurance policy to an irrevocable life insurance trust and designating the trust as the beneficiary of such policy, the insurance proceeds will be removed, not only from the insured’s estate, but from his or her spouse’s estate as well. This results in the insurance proceeds passing free of Federal and New York State estate tax to your children.

In addition to a traditional life insurance policy, you may want to consider the purchase of a “second to die” or “survivorship” life insurance policy. This policy differs from the traditional life insurance policy since the insurance proceeds are only paid on the death of the “second to die” of the spouses. This type of policy fits nicely into an estate plan since the bulk of the estate tax is usually due upon the death of the second spouse. In addition, this type of policy is generally less expensive than a traditional single life policy.

(3) Gifts —

Another effective way of reducing your taxable estate to save estate tax is to begin an annual gift-giving program whereby gifts are made to your children, grandchildren, and/or other beneficiaries each year. Starting January 1, 2018, you can give away up to $15,000 per year to as many individuals as you select ($30,000 if you are married). This amount is indexed for inflation. Further, there are trusts which can be set up to receive such gifts for any children or grandchildren, which allow you to retain some degree of control over the funds. These trusts offer significant advantages over gifts made to a minor through a Uniform Transfer to Minors Act (“UTMA”) account.

(4) QPRT – The “Last Home Run” in Estate Planning —

One of the most effective estate planning techniques allows you to give away your residence to a trust for the benefit of your children, thereby removing it from your taxable estate, yet still retain the right to occupy your home for a specific term of years. This technique is known as a Qualified Personal Residence Trust or “QPRT” and has been described as the “last home run” in estate planning.

The advantage of this technique is that the value of the gift to the trust is not the full market value of the residence but a reduced value equal to the value of your children’s right to receive the residence at the end of the term of the trust which will be substantially less than its current market value. For example, if a 70 year old person transferred his or her home (with a fair market value of $2 million) to a QPRT and retained the right to live in the home for 7 years, the value of the gift to the trust would only be approximately $1.3 million.*

There would be no Federal gift tax since the gift is less than the $11 million gift tax exemption. Accordingly, you removed an asset worth $2 million from your estate and only had to use $1.3 million of your $11 million gift tax exemption (leaving you with $9.7 million of the exemption to shelter other assets). This technique “leverages” the use of the gift tax exemption. In addition, all of the subsequent appreciation in the value of the home is removed from your taxable estate.

* This figure is based on current interest rates and will need to be calculated based on the interest rates at the time of the gift.

(5) Changing Residence for Tax Purposes —

For those of you considering changing residency to Florida or some other state, you should be aware that one of the “hottest” issues being raised by the New York State Department of Taxation is whether the taxpayer has in fact abandoned New York as his or her domicile for tax purposes. By carefully planning and structuring your move from New York, you can minimize the risk that New York State will attempt to impose its income and estate taxes on you.

(6) Health Care Proxy, Living Will and Power of Attorney —

New York law allows you to appoint a Health Care Proxy. This enables you to appoint someone (your proxy) to make health care decisions for you in the event you are unable to do so. In addition to the health care proxy, you may want to consider executing a Living Will which sets forth your wishes regarding the use of artificial life support systems (such as breathing and feeding tubes) in the event that you have a terminal illness or condition. Finally, you should also consider executing a Durable Power of Attorney which appoints someone as your agent to make financial decisions (as opposed to health care decisions) for you in the event you become incapacitated.

(7) Special Rules for Non-U.S. Citizen Spouses —

If you or your spouse is not a United States citizen, you should be aware that in order to avoid paying any estate tax on assets passing to such a non-citizen spouse, you must set up a trust for such spouse and the trustees of such trust must be U.S. citizens. This type of trust is known as a Qualified Domestic Trust or “Q-DOT”. Therefore, it is particularly important for individuals in this situation to have their Wills reviewed and revised to include a Q-DOT.

(8) Closely-Held Business —

For those of you who own your own businesses, you should consider what will happen to your business upon your death.  If there are other shareholders or partners in the business, you should consider a buy-sell or shareholder’s agreement (or Operating Agreement if a limited liability company) and, if you currently have such an agreement, it should be reviewed regularly every few years. In particular, if you do have a buy-sell agreement which requires your company to redeem (i.e., buy) the equity interest of a deceased shareholder and the buy-out is funded with life insurance (this type of agreement is sometimes referred to as a “redemption agreement”), the receipt of the insurance by the company will be subject to the alternative minimum tax.  If instead of a redemption agreement, you used a cross-purchase agreement which requires the surviving holder of equity (not the company) to buy the deceased equity interest, the receipt of the insurance would be free of any income tax.

Further, if you are the sole owner of the business and are considering passing the business to the younger members of your family, there are still certain devices which can be used to accomplish this goal if stringent IRS requirements are met.

(9) Generation-Skipping Transfer Tax —

Finally, in addition to the estate tax, you should also be aware that there is a Generation-Skipping Transfer Tax (the “GST Tax”) imposed on any transfer which “skips” a generation. For example, amounts left in a Will by a grandparent to a grandchild will be subject to the GST Tax – – which has the same rate as the estate tax. Like the estate tax there is currently a $11 million exemption from this tax. The GST Tax is extremely complicated and sometimes applies to situations which are less obvious than a direct bequest to a grandchild (for example, the GST Tax will apply upon the termination of a trust created for a child if the proceeds are paid to a grandchild).

Of course, this is only a brief outline of some of the issues which arise in the course of properly planning one’s estate and the particular facts of each situation warrant different considerations. We would be happy to speak with you regarding your particular estate plan.