1. If Married, Use Both Exemptions
Living Trust with Tax Planning
• Uses both spouses’ estate tax exemptions, doubling the amount protected from estate taxes and saving a substantial amount for your loved ones.
2. Remove Assets From Estate
Make Annual Tax-Free Gifts
• Simple, no-cost way to save estate taxes by reducing size of estate
• $15,000 ($30,000 if married) each year per recipient (amount tied to inflation)
• Unlimited gifts to charity and for medical/educational expenses paid to provider
Transfer Life Insurance Policies to Irrevocable Life Insurance Trust
• Removes death benefits of existing life insurance policies from estate
• Included in estate if you die within three years of transfer
Qualified Personal Residence Trust
• Removes home from estate at discounted value
• You can continue to live there
Grantor Retained Annuity Trust / Grantor Retained Unitrust
• Removes income-producing assets from estate at discounted value
• You can continue to receive income
Limited Liability Company / Family Limited Partnership
• Lets you start transferring assets to children now to reduce your taxable estate
• Often discounts value of business, farm, real estate or stock
• Can protect the assets from future lawsuits, creditors, spouses
• You keep control
Charitable Remainder Trust
• Converts appreciated asset into lifetime income with no capital gains tax
• Saves estate taxes (asset out of estate) and income taxes (charitable deduction)
• Charity receives trust assets after you die
Charitable Lead Trust
• Removes asset from your estate, saving estate taxes
• Income goes to charity for set time period, then trust assets go to loved ones
3. Buy Life Insurance
Through Irrevocable Life Insurance Trust
• Can be inexpensive way to pay estate taxes and/or replace charitable gifts
• Death benefits not included in your estate
Depending on your age and health, buying life insurance can be an inexpensive way to replace an asset given to charity and/or to pay any remaining estate taxes. The three-year rule mentioned earlier does not apply to new policies. But you should not be the owner of the policy — that would increase your taxable estate and estate taxes. To keep the death benefits out of your estate, set up an ILIT and have the trustee purchase the policy for you.
A CLT is just about the opposite of a CRT. You transfer an asset to the trust, which reduces the size of your estate and saves estate taxes. But instead of paying the income to you, the trust pays it to a charity for a set number of years or until you die. After the trust ends, the trust assets will go to your spouse, children or other beneficiaries.
A CRT lets you convert a highly appreciated asset (like stocks or investment real estate) into a lifetime income without paying capital gains tax when the asset is sold. It also reduces your income and estate taxes, and lets you benefit a charity that has special meaning to you.
With a CRT, you transfer the asset to an irrevocable trust. This removes it from your estate. You also get an immediate charitable income tax deduction.
The trust then sells the asset at market value, paying no capital gains tax, and reinvests in income-producing assets. For the rest of your life, the trust pays you an income. Since the principal has not been reduced by capital gains tax, you can receive more income over your lifetime than if you had sold the asset yourself. After you die, the trust assets go to the charity you have chosen.
FLPs and LLCs let you reduce estate taxes by transferring assets like a family business, farm, real estate or stocks to your children now, and still keep some control. They can also protect the assets from future lawsuits and creditors.
Here’s how they work. You and your spouse can set up an LLC or FLP and transfer assets to it. In exchange, you receive ownership interests. Though you have a fiduciary obligation to other owners, you control the LLC (as manager) or FLP (as general partner). You can give ownership interests to your children, which removes value from your taxable estate. These interests cannot be sold or transferred without your approval, and because there is no market for these interests, their value is often discounted. This lets you transfer the underlying assets to your children at a reduced value, without losing control.
These are much like a QPRT. The main difference is that a GRAT or GRUT lets you transfer an income-producing asset (stock, real estate, business) to a trust for a set number of years, removing it from your estate — and still receive the income. (If the income is a set amount, the trust is called a GRAT. If the income fluctuates, it’s called a GRUT.)
When the trust ends, the asset will go to the beneficiaries of the trust. Since they will not receive it until then, the value of the gift is reduced. If you die before the trust ends, some or all of the asset may be in your estate.
A QPRT removes your home, a substantial asset, from your estate now, yet you can continue to live there. It allows you to transfer your home to a trust (QPRT) for a period of time, usually 10-15 years. During this time, you continue to live there. When the trust term is up, the home transfers to the trust beneficiaries, usually your children. If you wish to stay there longer, you may make arrangements to pay rent. If you die before the trust term ends, your home will be included in your estate, just as it would without a QPRT.
A QPRT “leverages” your estate tax exemption. Since your children will not receive the house until the trust ends, its value as a gift is reduced. For example, if the current value of your home is $250,000 and you put it in a QPRT for 15 years, its value for tax purposes could be as little as $75,000. That leaves much more of your exemption for other assets.
You can remove the value of your insurance from your estate by making an ILIT the owner of the policies. As long as you live three years after the transfer of an existing policy, the death benefits will not be included in your estate.
Usually the ILIT is also beneficiary of the policy, giving you the option of keeping the proceeds in the trust for years, with periodic distributions to your spouse, children and grandchildren. Proceeds kept in the trust are protected from irresponsible spending, creditors and even spouses.
In 2020, federal law lets you give up to $15,000 ($30,000 if married) to as many people as you wish each year. So if you give $15,000 to each of your two children and five grandchildren, you will reduce your estate by $105,000 a year (7 x $15,000), $210,000 if your spouse joins you. This annual gift tax exemption amount is tied to inflation and increases every few years. State laws may differ regarding gift tax.
If you give more than the annual gift tax exemption amount, the excess will be considered a taxable gift and will be applied against your “unified” gift and estate tax exemption (if you use it while you are living, it’s considered a gift tax exemption; if you use it after you die, it’s an estate tax exemption). Charitable gifts are still unlimited. So are gifts for tuition and medical expenses if you give directly to the institution.
One way to reduce estate taxes is to reduce the size of your estate before you die. So, spend some and enjoy it! Also, you probably know whom you want to have your assets after you die. If you can afford it, why not make some gifts now and save estate taxes? It can be very satisfying to see the results of your gifts, something you can’t do if you wait until you die.
Appreciating assets are best to give because any future appreciation will also be out of your estate. Gifted assets keep your cost basis (what you paid for them), so recipients may pay capital gains tax when they sell. But at 15% on assets held longer than 12 months, that would be less than estate taxes (35-55%) if you keep the assets until you die.
Some popular strategies are introduced below. Note that these are irrevocable, so you can’t change your mind later.