estate tax

[bots2019]

Does anyone have experience or an understanding of the methods for tax efficiently transitioning assets to family members? I am already aware of the annual gifting exemptions (currently 12k) and lifetime gift exemption (currently $1M, but reduces estate exemption at death). Specifically, are there trusts or other methods that can be employed?

Also, I’m curious if anyone knows of any restrictions on how the annual gift exemption can be used. My understanding is that any person can give any other person a gift up to the exemption amount without any taxes being incurred. Are there any regulations against ‘pass-thru’ gifting? For example, if person A wants to pass as much money to person B as possible, couldn’t person A pass 12k to person B, and 12k to person C who then would pass it to person B? Obviously, person C would be under no obligation to pass the money to person B, so it seems you’d have to trust them, but it seems that this type of approach must be legal?

 

[ERD50]

I suppose that if you gave $12K each to ten different people, and 9 of those people turned around and gifted $12K each to the first person, it would be legal (but read on....).

However, if required, I think that you would have a tough time proving that the 9 people actually received a 'gift'. As I understand it, a gift with strings attached does not qualify as a gift. So what encouraged all these people to gift this to the first person? It would look, and probably would be (if ever audited) considered tax evasion. But I am not a lawyer.

This is one of the things I *hate* about laws structured like this - the complexity gets it down to 'intent', and we cannot read people's minds. Our tax laws should not be structured to require mind reading, IMO.

Also, if person "B" in your example needs the money for medical or education reasons, I believe that money used directly for those purposes does not fall under the gift limitations, but of course you will need to do some research on this to understand exactly what and what does not qualify.

-ERD50

 

[freebird5825]

Easiest answer...consult an estate attorney who specializes in trusts in YOUR state.

I recently set up a living trust and all associated documents for myself (no heirs, no spouse). it was grueling work, but it is by far the smartest money I ever spent except for financial planning with a CFP back in 2002.

My house and assets are all transferred in, beneficiaries named, future family trust provisions for my life partner, pour-over will in place for assets acquired after trust executed, etc etc.

My poor attorney earned his money. I read every line of the trust and will and HCP and yadda yadda yadda and had lots of modifications. Beware the boilerplate!

good luck!
FB

 

[MasterBlaster]

As I understand it, The lifetime gift maximum has been used so any other gifts (ie. the $12k gifts) would incur gift taxes. However if the bypass trust that was set up did not provide for those gifts then they would not be allowed. One cannot (easily) alter a trust after it has been set up and executed by the decedant.

In my opinion the family is going to have to pay estate taxes on the remaining assets. You are a little late in the game to be thinking of estate tax avoidance.

Your best bet here is to speak with an estate attorney. Perhaps some sort of charitable remainder trust or something else could be constructed. Don't exepect to receive everything though.

 

[ERD50]

As I understand it, The lifetime gift maximum has been used so any other gifts (ie. the $12k gifts) would incur gift taxes.

The annual gifting (within the limit for that year) does not incur taxes. It is excluded and does not factor into the lifetime maximums. It is a total 'freebie'. Check the IRS website on that, it is actually quite clear on that point.

-ERD50

edit/add - here is an example, only amounts above the $12K factor into anything at all (at least that is how I interpret this, and it seems pretty clear):

http://www.irs.gov/publications/p950/ar02.html#d0e308

Applying the Unified Credit to Gift Tax

After you determine which of your gifts are taxable, you figure the amount of gift tax on the total taxable gifts and apply your unified credit for the year.
Example. In 2007, you give your niece, Mary, a cash gift of $8,000. It is your only gift to her this year. You pay the $15,000 college tuition of your friend, David. You give your 25-year-old daughter, Lisa, $25,000. You also give your 27-year-old son, Ken, $25,000. Before 2007, you had never given a taxable gift. You apply the exceptions to the gift tax and the unified credit as follows:

1. Apply the educational exclusion. Payment of tuition expenses is not subject to the gift tax. Therefore, the gift to David is not a taxable gift.
2. Apply the annual exclusion. The first $12,000 you give someone during 2007 is not a taxable gift. Therefore, your $8,000 gift to Mary, the first $12,000 of your gift to Lisa, and the first $12,000 of your gift to Ken are not taxable gifts.
3. Apply the unified credit. The gift tax on $26,000 ($13,000 remaining from your gift to Lisa plus $13,000 remaining from your gift to Ken) is $5,120. See the Instructions for Form 709 for the Table for Computing Gift Tax for further information. You subtract the $5,120 from your unified credit of $345,800 for 2007. The unified credit that you can use against the gift tax in a later year is $340,680.

You do not have to pay any gift tax for 2007. However, you do have to file Form 709.

 

[MasterBlaster]

ERD50:

I could be wrong here but as I understand it the gifts come out of the $1MM estate exclusion. Thats why they call it the (lifetime gift exemption). The unified gift tax credit just limits how much you can gift during your lifetime without paying gift taxes.

Please enlighten me if I have this wrong.

 

[Martha]

MasterBlaster, the 12,000 annual exclusion per person does not come out of the estate exclusion. ERD is right, it is never counted and does not have to be reported on form 709.

Publication 950 (8/2007), Introduction to Estate and Gift Taxes

 

[lazygood4nothinbum]

Are there any regulations against ‘pass-thru’ gifting? For example, if person A wants to pass as much money to person B as possible, couldn’t person A pass 12k to person B, and 12k to person C who then would pass it to person B? Obviously, person C would be under no obligation to pass the money to person B, so it seems you’d have to trust them, but it seems that this type of approach must be legal?

yes, the regulation is called tax evasion.

beyond gifting the current $12k/year, you can also make limitless payments tax free directly to the service provider for the benefit of another person's medical or education needs.

but of course, the very best way to avoid the death tax is to not die.

edit: here's some fun for martha but i think this is a case about cross-gifting as tax evasion...

http://www.ca8.uscourts.gov/opndir/01/06/002171P.pdf

the tax court found that the transactions at issue involved cross-gifts, denied claimed annual exclusions, and upheld the tax

deficiencies and a portion of the penalties...The IRS reasoned that the gifts to each of the donors' own children were valid gifts, but that the gifts to each niece and nephew were constructive gifts to the donors' own children.

this tax evasion idea of cross gifting might also be known as reciprocal arrangements.​

​

​

 

[bots2019]

You are a little late in the game to be thinking of estate tax avoidance

Agreed. But you try taking estate matters with a late-80s, depression era WWII vet!

Btw - family is working with an trusts & estates lawyer. As an extended family member I haven't been involved in those discussions, but have heard some stuff second hand. And his direction is consistent with Martha/ERD on the annual gifting. Currently, all heirs are getting the annual exemption amount. This has been helpful in padding the ER stash.

 

[bots2019]

this tax evasion idea of cross gifting might also be known as reciprocal arrangements.

Thanks for the citation lazy. Seems pretty clear they're looking for who benefits from the $$ in the end...

 

[Nords]

Agreed. But you try taking estate matters with a late-80s, depression era WWII vet!
Btw - family is working with an trusts & estates lawyer. As an extended family member I haven't been involved in those discussions, but have heard some stuff second hand. And his direction is consistent with Martha/ERD on the annual gifting. Currently, all heirs are getting the annual exemption amount. This has been helpful in padding the ER stash.

It sounds like you've already seen a great job of avoiding as much estate tax as possible. Much of the reason behind trusts also involves avoiding probate expenses, which in some states could whack another 3-4% of assets.

Another very good reason to work with a local lawyer is the state estate tax laws. Everybody is distracted by the feds while the states swoop in and clean up.

Keep in mind that IRAs (if used by your GM/GF) and most life insurance policies are handled outside the estate and generally not subject to estate tax. Some estate plans use life insurance as a way of generating the cash to pay the estate tax.

I used to think that a little friendly "directed gifting" among family members was just fine because, hey, you gotta know your own family. Then I watched it turn sour in a family very close to ours. Now my advice is that no matter how much or how well you think you know your family members, if you start swapping gifts with strings attached then you're gonna get a real education.

 

[kaneohe]

Keep in mind that IRAs (if used by your GM/GF) and most life insurance policies are handled outside the estate and generally not subject to estate tax. Some estate plans use life insurance as a way of generating the cash to pay the estate tax.

Nords,

Perhaps you meant this and just used the wrong word.......
My impression is that IRAs and life insurance are not subject to probate fees
(unless they go to estate) but they are subject to estate tax (except if they go to spouse).

 

[Martha]

yes, the regulation is called tax evasion.

beyond gifting the current $12k/year, you can also make limitless payments tax free directly to the service provider for the benefit of another person's medical or education needs.

but of course, the very best way to avoid the death tax is to not die.

edit: here's some fun for martha but i think this is a case about cross-gifting as tax evasion...

http://www.ca8.uscourts.gov/opndir/01/06/002171P.pdf
[/font]

this tax evasion idea of cross gifting might also be known as reciprocal arrangements.​

[/font]​

Thanks for the link. Because tax law can get so complex, it can be hard to know what is permissible and what is not. The only way to know is to ask. (And then you still might not know.)

 

[Nords]

Nords,
Perhaps you meant this and just used the wrong word.......
My impression is that IRAs and life insurance are not subject to probate fees
(unless they go to estate) but they are subject to estate tax (except if they go to spouse).

Nope, my impression is that life insurance is popular as an estate-planning tool (among other reasons) because it's generally not subject to estate tax.

And my impression is also that an IRA, properly bequeathed and retitled, is not subject to estate tax and can be stretched out over the beneficiary's lifetime. That's possibly subject to income tax but not to estate tax.

I agree that they do pass outside of probate and are not subject to probate fees.

As has been amply demonstrated here, I've been wrong before. I don't carry life insurance for estate-planning purposes (or any other reasons) and we're converting to Roth IRAs-- so I haven't been keeping up with the estate-tax issues.

Anyone have a reference?

 

[Martha]

Nope, my impression is that life insurance is popular as an estate-planning tool (among other reasons) because it's generally not subject to estate tax.

And my impression is also that an IRA, properly bequeathed and retitled, is not subject to estate tax and can be stretched out over the beneficiary's lifetime. That's possibly subject to income tax but not to estate tax.

I agree that they do pass outside of probate and are not subject to probate fees.

As has been amply demonstrated here, I've been wrong before. I don't carry life insurance for estate-planning purposes (or any other reasons) and we're converting to Roth IRAs-- so I haven't been keeping up with the estate-tax issues.

Anyone have a reference?

With some gotcha's, life insurance owned not by you but by a life insurance trust or owned by your children can be used to minimize estate taxes. But if you own the policy, an estate tax will have to be paid when you die. Also, transferring life insurance you own to another may have a gift tax consequence.

Here is a couple of articles that talk a little about life insurance trusts: http://trusts-estates.lawyers.com/Irrevocable-Life-Insurance-Trust.html
http://en.wikipedia.org/wiki/Life_insurance_trust


For example, a friend of mine has life insurance on his life. The policy has a cash value of 50,000. He gave the policy to his children. A gift tax return has to be filed and it will count against his estate tax exemption. But, the advantage is that the payout on the policy when he dies is about $250,000 and there will not be an estate tax on that payout.

IRAs are subject to estate taxes.

Exception for the foregoing is if your spouse is the beneficiary. The is no estate tax on assets left to one spouse by the other.

Note my signature line.

 

[ERD50]

Nope, my impression is that life insurance is popular as an estate-planning tool (among other reasons) because it's generally not subject to estate tax.

.... I don't carry life insurance for estate-planning purposes (or any other reasons) and we're converting to Roth IRAs-- so I haven't been keeping up with the estate-tax issues.

Anyone have a reference?

Well, here is my understanding of how life insurance is used in estate planning, and IMO, it is a bit of a circle game. But it might make sense to make cash available, but there are probably better ways:

1) Money is gifted to one or several individuals, usually something like the $12K/year/person so it is not subject to any gift tax issues.

2) The individuals use the money to pay premiums on a life insurance policy on the life of the person who owns the big estate.

3) The policy must be held outside the estate - the individuals own it. This way it isn't an estate issue at all.

So, if the estate has most of it's money tied up in illiquid assets (a business for example), the ins policy can provide the cash to pay estate taxes on that business. I imagine there are more efficient ways to do this, but an insurance salesman is unlikely to offer any ideas.

Outside of that, I fail to see how it is a benefit to anyone. Unless the people think life insurance is a good investment, it would seem better to take the annual gifting and invest it.

-ERD50

 

[harley]

I don't have a reference, but I [-]know [/-] think Nords is right. Life insurance is not considered part of the estate, and is an excellent way to pass on some money without being taxed, or as Nords said, to pay the estate taxes. However, insurance companies are not in the business of giving away money, so they make it difficult and VERY expensive to get a high dollar policy at an advanced age.

The traditional IRAs work well too, and Roths even more so. However, they haven't been around all that long. And most high value individuals didn't qualify for investing in them, so they aren't much good for the sitation you are talking about.

However, for yourself, if you are planning to leave a large estate, start the accounts early, get the life (Term) insurance going, and you'll be in better shape to keep a few extra shekels out of Uncle Sam's hands.

 

[harley]

Life insurance owned not by you but by a life insurance trust or owned by your children can be used to minimize estate taxes. But if you own the policy, an estate tax will have to be paid when you die. Also, transferring life insurance you own to another may have a gift tax consequence.

For example, a friend of mine has life insurance on his life. The policy has a cash value of 50,000. He gave the policy to his children. A gift tax return has to be filed and it will count against his estate tax exemption. But, the advantage is that the payout on the policy when he dies is about $250,000 and there will not be an estate tax on that payout.

IRAs are subject to estate taxes.

Exception for the foregoing is if your spouse is the beneficiary. The is no estate tax on assets left to one spouse by the other.

Martha and ERD50, thanks for making the point about the policy ownership. I forgot about that.

As far as the IRA is concerned, I thought it passed to the heir outside the estate tax, then needed to be withdrawn over the expected life span of the recipient with taxes being paid on the withdrawals. If it is taxed as part of the estate, do you then get to draw it down tax free? If so, then is the only advantage to having the Roth that it doesn't have the withdrawal requirement for the beneficiary? I've been thinking of using it for possible estate planning, but it sounds like I've been misunderstandding how it would work. Thanks.

 

[ERD50]

Life insurance owned not by you but by a life insurance trust or owned by your children can be used to minimize estate taxes.

Actually, I kind of disagree with that statement - though I'll admit, it may just be semantics.

It is the gifting of money out of the estate below the annual per-person limit that minimizes estate taxes.

Whether the individuals who receive the gifts put it into an insurance policy, the stock market, or spend it on crack, is an independent decision. The estate taxes will be the same in any case, as long as the gifting was done.

Or do I have something wrong?

Insurance salespeople like to blend the two, but as I see it, gifting is gifting, and buying life insurance is buying life insurance. If one or the other don't make sense on their own, it won't make sense to combine them. I think a lot of salespeople rely on the premise that a lot of people don't understand the concept of independent variables.

-ERD50

 

[Martha]

Martha and ERD50, thanks for making the point about the policy ownership. I forgot about that.

As far as the IRA is concerned, I thought it passed to the heir outside the estate tax, then needed to be withdrawn over the expected life span of the recipient with taxes being paid on the withdrawals. If it is taxed as part of the estate, do you then get to draw it down tax free? If so, then is the only advantage to having the Roth that it doesn't have the withdrawal requirement for the beneficiary? I've been thinking of using it for possible estate planning, but it sounds like I've been misunderstandding how it would work. Thanks.

I think that you are mixing up estate tax and income tax issues. There is an estate tax on the IRA's value at death. However, for traditional IRAs income taxes can be minimized by various withdrawal options.

 

[Martha]

Actually, I kind of disagree with that statement - though I'll admit, it may just be semantics.

It is the gifting of money out of the estate below the annual per-person limit that minimizes estate taxes.

Whether the individuals who receive the gifts put it into an insurance policy, the stock market, or spend it on crack, is an independent decision. The estate taxes will be the same in any case, as long as the gifting was done.

Or do I have something wrong?

Insurance salespeople like to blend the two, but as I see it, gifting is gifting, and buying life insurance is buying life insurance. If one or the other don't make sense on their own, it won't make sense to combine them. I think a lot of salespeople rely on the premise that a lot of people don't understand the concept of independent variables.

-ERD50

I am not sure of your point. Maybe I did not flesh out what I said enough. People buy life insurance for a number of different reasons. You buy it and you own the policy and when you die the payout is subject to estate taxes. However, you have the option, with some restrictions, of giving the policy away. The advantage of giving the policy away is that what will be counted against your estate is the value at the time you gave it away, not the payout amount when you die, provided that you do not die for at least three years from the date you transfered it. Now if the value when you give it away is less than 12,000, no tax is due ever. If the value is greater than that, then the excess value counts against your unified credit. Much like the example I gave above. Of course, if you give the policy away to your kids, they could cash it in now and have a party. Or they could delay gratification and wait for the big payout when you die. Often when the policy is given away the giver pays the premiums going forward, which is also a gift. If Crummy trust provisions were properly set used, the 12,000 per year gift exclusion can be used for the premium payments.

Other people buy life insurance specifically for the purpose of heirs having cash to pay estate taxes. In this case generally from the get go the policy is owned and controlled by an irrevocable trust.

The links I mentioned outline a few issues with life insurance trusts.

 

[Nords]

Nords,
Perhaps you meant this and just used the wrong word.......
My impression is that IRAs and life insurance are not subject to probate fees
(unless they go to estate) but they are subject to estate tax (except if they go to spouse).

Dang, Kaneohe, I stand corrected. Thank you for pointing that out.

I have life insurance confused with trusts and other owners. And that IRA estate tax is sure news to me. I thought IRAs were totally outside of estates.

Gonna be some big gifting/caregiving salaries or charitable donations when we're much older-- I don't want our kid or caregivers to think that we're worth more dead than alive.

 

[harley]

Gonna be some big gifting/caregiving salaries or charitable donations when we're much older-- I don't want our kid or caregivers to think that we're worth more dead than alive.

Especially in 2 years, when the estate tax goes away completely (for that year, at least). If you've got a big estate, don't turn your backs on the kids.

 

[ERD50]

I am not sure of your point. Maybe I did not flesh out what I said enough. People buy life insurance for a number of different reasons. You buy it and you own the policy and when you die the payout is subject to estate taxes. However, you have the option, with some restrictions, of giving the policy away. The advantage of giving the policy away is that what will be counted against your estate is the value at the time you gave it away, not the payout amount when you die, provided that you do not die for at least three years from the date you transfered it.

OK, I understand the conditions. But the only way I can get the math to work is if one assumes that (on average) a life insurance policy is a better investment than the alternatives.

It makes sense to get the asset with the most appreciation potential out of the estate, to avoid those high estate tax rates. But is that a Life Insurance policy? If so, it seems we should all be buying policies as investments, estate tax issues or not. But there sure isn't much support on this forum for life insurance as an investment.

Compare the two options, when there is an existing policy in place:

1) Gift the insurance policy to the heirs.

2) Hold the insurance policy in the estate and gift an equal amount of cash to the heirs to invest.



Example for #1: An Estate has a $120K cash value policy as p/o their total NW. They give away shares of it to their ten heirs. This is within the 12K/person/year limit, so no tax consequence. Each heir is $12K richer, the estate is $120K smaller.

Example for #2: Same Estate, but give away $12K cash to each of their ten heirs. Like above, no tax consequence, each heir is $12K richer, the estate is $120K smaller.


So how can insurance (on average) benefit the heirs/estate w/o also being a superior investment vehicle on it's own? Your example, of a $50K cash value policy growing to $250K is only valid if other investment options would grow to less than that $250K in that same time. Which seems like another way of saying that insurance *is* a good investment. But again, I don't see any support for that idea on this forum.

That is what I have never understood, and all the explanations I've seen a have been slanted (gifting insurance versus no gifting at all), not in an apples-to-apples comparison of gifting cash to invest versus gifting insurance.

-ERD50

 

[kaneohe]

Perhaps it is because life insurance here is being used because it is needed to pay estate taxes on the rest of the estate......for the same reason you buy any other kind of insurance......that you think you will need it for sure but w/ the timing uncertain.
If you put the money in the insurance into another investment but you die tomorrow or next yr, it may not have enough time to grow large enough . So even though on average it may not be the best investment, you know it will be there when you need it.

Removing it from the estate also makes it more efficient since the estate tax is figured on the value of the rest of the estate. If you left the life insurance in the estate, the death value of the insurance could be significantly larger than the cash value resulting in a larger estate tax.