Estate Tax - Introduction

The federal estate tax is basically a tax on orphans because it doesn't apply to any assets left to a surviving spouse. However, when the second spouse dies, then the government steps in and demands as much as 50% of the value of an estate. When the main asset in the estate is a small business or farm, it sometimes has to be sold at distress prices in order to pay the taxes. However, the federal estate tax can be eliminated or at least greatly diminished through advance tax planning. If you don't want the government to consume a large part of your estate, you have to spend some time and money now to keep that from happening after you are gone. To the extent that the estate tax can be avoided by advance planning, it can reasonably be described as a "voluntary" tax. 

The federal estate tax has been called a "voluntary tax" because there are so many legal ways to avoid this tax with advance planning. However, few families will spend the time or money to restructure their assets to prevent the IRS from taking up to 55% in one generation, up to 75% in two generations and up to 88% in three generations. (These figures only apply to taxable estates in excess of the available exemptions and exclusions, discussed below.)

 Basically, estate planning isn't done for your own benefit. It's done for your children. The current estate tax can be easily avoided until the death of both parents. 

Thus, the estate tax is virtually a tax on orphans. When you and your spouse are both gone, the IRS often gets a big chunk of what's left. That is, they will unless you are willing to spend a little time now to find legal ways to sidestep the problem. It's very easy to avoid the federal estate tax on a total estate of up to $2 million. Beyond that, it requires a little bit of effort. For estates of $3 million and up, the federal estate tax can consume 40% to 45% of the total estate. 

If the value of your estate will be less than $1,000,000 at the time of your death, you don't need to spend any time or money on estate planning to avoid the federal estate tax. The $1 million exemption is scheduled to increase to $1.5 million after 2003 and to increase to $3 million in the year 2010. Details on the scheduled changes in the estate tax exemption are described in our report on the Estate Tax Shell Game.

If you are married, this amount can be doubled with an arrangement known as a "credit shelter trust" or an "A/B Trust".  It's a very basic component of the "toolkit" used by every estate tax planning lawyer. 

If you plan to leave everything you own to your spouse and if you don't care what happens to it after that, then there's little reason to spend any time or money on estate planning. 

But - if it angers you to think that the IRS will force your executor to sell off many of your assets - and even your business - to pay the estate taxes after you and your spouse are gone, then you have two other choices. One is to leave the residue of your estate to a charity. The other is to spend some time now to arrange your assets so that they go to the people who are important to you. Most likely, that's your children or your grandchildren. 

The current federal estate tax law offers a variety of legal ways to greatly reduce the estate tax. One example is with a family limited partnership. Assume you transfer some assets to a family partnership in exchange for an interest as a limited partner. The assets in the partnership can't be sold by the limited partner, so you have just placed a restriction on the use of this asset. A buyer won't pay as much for it as for the assets you put into the partnership. Hence, the law recognizes that a discount is appropriate in valuing the limited partnership interest in your estate. At the present time, the IRS and the courts have been accepting discounts of from 20% to 40%. (In some cases, the discounts have been even higher.) 

Assuming that your estate is worth $3 million, this one device could save your heirs as much as $500,000 in estate taxes.  

Essentially, the basic methods of estate tax savings involve making gifts while you are alive, structuring your assets to reduce their value or converting your estate into an income stream that ceases at your death (an annuity). 

For example, you could eliminate the estate tax overnight by exchanging all of your assets for a life income annuity for yourself and your spouse. In some cases, you might want to make one or more of your children beneficiaries of part of your annuity. The three most common methods of doing this include (1) a life insurance company commercial annuity, (2) an annuity from a charitable trust , or (3) a private, unsecured annuity . If you sell property to your children or grandchildren in exchange for a life income annuity, at the time of your death, those assets are outside of your estate and the assets are owned by your children or grandchildren. 

Copyright, 2003, Vernon K. Jacobs

Vernon Jacobs is the Editor/Publisher of The International Wealth Protection Reports, which are a collection of research reports on legal methods of asset protection and tax avoidance. Further information on this subject is available at http://www.offshorepress.com/  Jacobs is a CPA who has worked as a free lance tax and financial author/editor since 1977. Details about his credentials and experience are online at http://www.offshorepress.com/vkjcpa/  

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