Five levels of estate planning is a systematic approach to explaining estate planning in a way that you can easily follow. Which of the five levels do you need to complete based on your specific objectives and circumstances.
Level One: Basic Plan
The situation for level one planning is that you either don’t have the will or belief in life, or your existing desires or beliefs in life are outdated or inadequate. The goals of this type of planning are to:
o reduce or eliminate land taxes;
o avoid the costs, delays and publicity associated with probate in the event of death or disability; and
o protect the heirs from their disability, their disability, their creditors and their predators, including former spouses.
To achieve this goal, you will use wills, revocable living trusts that allocate married persons property between credit holding trusts and marital trusts, general powers of attorney for financial matters and durable power of attorneys for health care and living wills.
Level Two: The Irrevocable Life Insurance Trust (ILIT)
The situation for level two planning is that your projected land is greater than the land tax exemption. Despite current irregularities in inheritance and generational transfer taxes, it’s likely that Congress will refund both taxes (perhaps even retroactively) sometime this year. Otherwise, on January 1, 2011, the property tax exemption (which was $3.5 million in 2009) would be $1 million, and the property tax rate (which was 45% in 2009) would be 55%. However, you can give cash gifts to ILIT using the annual gift tax exemption of $13,000/$26,000 per recipient.
Tier Three: Limited Family Partnership
The situation for a tier three plan is that you have a projected property tax liability that exceeds the life insurance purchased at tier two. If your $1 million gift tax exemption ($2 million for married couples) is used to make a lifetime gift, the gifted property and all future awards and income on that property will be removed from your inheritance.
More people will be willing to give gifts to their children if they can continue to manage the given property. A family limited partnership (FLP) or family limited liability company (FLLC) can play a valuable role in this situation. You will typically become a partner or general manager and in that capacity, continue to manage FLP or FLLC assets. You may even take a reasonable management fee for your services as a general partner or manager. In addition, by providing FLP or FLLC interest to ILIT, FLP or FLLC earnings can be used to pay premiums, thereby waiving the $13,000 / $26,000 annual gift tax exemption for other types of prizes.
Level Four: Eligible Personal Residential Trust and Grantor-Retained Annuity Trust
The situation for level four planning is the additional need to deduct your estate after your $1 million/$2 million gift tax exemption is used. Even though paying gift tax is cheaper than paying land tax, most people don’t want to pay gift tax. There are several techniques for giving large gifts to children and grandchildren without paying significant gift taxes.
One of the techniques is Qualified Personal Residence Trust (QPRT). QPRT allows you to transfer a residence or vacation home to a trust for the benefit of your children, while retaining the right to use the residence for a period of several years. By retaining the right to occupy the residence, the salvage value of the interest is reduced, along with any taxable gifts.
Another technique is the grant-giver fixed annuity (GRAT). GRAT is similar to QPRT. A typical GRAT is funded with income-generating properties such as subsection S shares or FLP or FLLC interests. The GRAT pays you a fixed annuity for a certain period of year. Due to a retained annuity, the reward for the remainder (of your children) is substantially less than the current value of the property.
Both QPRT and GRAT can be designed with a period long enough to reduce the value of the remaining interest paid to your children to a nominal amount or even to zero. However, if you do not survive the stated period of time, the property is included in your inheritance. Therefore, it is recommended that ILIT be funded as a “hedge” against your death before the end of the stated term.
Level Five: Zero Plantation-Tax Plan
Level five planning is the desire to “let go” the IRS. This strategy combines life insurance gifts with gifts to charity. For example, take a married couple, both 55 years old, with an estate of $20 million. Assume that there is no growth or depletion of assets and that both spouses die in one year when the property tax exemption is $3.5 million, and the highest property tax rate is 45%.
With a typical marital credit holding trust, when the first spouse dies, $3.5 million is allocated to the credit holding trust and $16.5 million to the marital trust. No federal estate taxes are due. However, on the death of the surviving spouse, the inheritance tax due is $5.85 million. The end result was that the children inherited only $14.15 million.
With a zero estate tax plan, ILIT (with generation-skipping terms) is funded with a $13 million second-to-death life insurance policy. These gifts reduced the value of the estate to $18 million. In addition, the couple’s living trustees each leave $3.5 million (amount exempt from land taxes) to their children upon the death of the surviving spouse. The balance of their assets ($11 million) goes to public charities or private-plantation-tax-free foundations. To summarize, the zero land tax plan provides $20 million (ie, $13 million from ILIT and $7 million from living trusts) to children, not $14.15 million; the charity received $11 million instead of nothing; and the IRS received nothing but $5.85 million.
In short, with some advanced planning, it is possible to reduce estate taxes, avoid probates, establish your will, and protect your heirs from creditors, ex-spouse and estate taxes.
AS LONG AS THIS ARTICLE CONTAINS TAX MATTERS, IT IS NOT INTENDED OR WRITTEN FOR TAXPAYER’S USE AND CANNOT BE USED BY TAXPAYER FOR THE PURPOSE OF AVOIDING PUNISHMENTS THAT MAY BE ESTABLISHED ON THE TAXPAYER, ACCORDING TO CIRCULAR LETTER 230.