Below you will find some of the most frequently asked questions dealing with the Federal Estate Taxes as well as Maryland Estate Taxes. Please contact our office with any additional questions or concerns you may have.
1. What are Estate Taxes and Who has to pay them?
Estate Tax is a tax levied by the federal government and is paid depending on how much you own when you die. If applicable, your estate may have to pay the taxes before your assets can be distributed to your heirs. Maryland also has an estate tax often referred to as a "pick up" tax and it is calculated by deducting the inheritance tax paid in Maryland from the allowable federal credit for state death tax.
Estate taxes are expensive; in 2004 the taxes (both state and federal) range from 45-50%. Estate taxes are due in cash, in full and usually within nine months to a year after the date of death. Usually, most estates do not have large amounts of cash so they must liquidate assets to pay for the tax. This means selling property from the estate to pay the tax, leaving fewer assets to pass to your family and loved ones.
Below is a current schedule of whether or not your estate will be taxed by the Federal Government. If your estate is over the exemption amount, Federal Estate Tax is due when you die.
Date of Death Exemption
2004, 2005 $1.5 Million
2006, 2007, 2008 $2 Million
2009 $3.5 Million
2010 $None (Repealed for that year only)
2011 and thereafter $1 Million
2. What is the value of my estate?
The value of your estate for tax purposes is called your "net estate". To determine the current value of your net estate add your assets then subtract all of your debts (both long and short term). Items to include in your estate are homes, business interests, bank accounts, investments, personal property, IRA's, retirement plans and death benefits from your life insurance.
3. How can a person reduce their estate taxes or even eliminate them?
Below are a number of common methods used to reduce or eliminate taxes:
1. If married use both estate tax exemptions
2. Buy a life insurance policy to pay taxes
3. Remove assets from your estate by using:
a. Tax Free Gifts
b. Qualified Personal Residence Trusts
c. Irrevocable Life Insurance Trusts
d. Grantor Retained Annuity Trusts
e. Family Limited Partnerships
f. Charitable Remainder Trusts
g. Charitable Lead Trusts
4. What does using both exemptions mean?
If your spouse is a U.S. citizen you are permitted to leave them an unlimited amount when you die, without paying any estate tax. This seems like a perfect solution but can be very troubling because it in essence wastes one exemption. Take a look.
Jack and Jill have a net estate worth about $3 Million and they both die in 2004. Jack dies first and leaves his estate to Jill tax-free because of the unlimited spousal exemption. Jill dies some time later and leaves her estate to the children. Jill now only has a 1.5 Million dollar exemption so her children are taxed on the other 1.5 Million. That is approximately $750,000.00 in estate taxes due from the children after Jill dies. The children will probably have to sell a large portion of the estate to pay the tax.
With proper planning this situation can be avoided. The answer is to use both exemptions. Jack and Jill could form living (revocable) trusts with provisions that spilt their estate into 2 trusts of 1.5 Million dollars each, by doing so when either one of them passes they will use their 1.5 Million dollar exemption and their 3 Million dollar estate will pass to their heirs without estate tax.
This is not the only answer, there are a number of possible solutions to the problem, this just illustrates that proper tax and estate planning can be well worth the effort.
5. Buying Additional Life Insurance
Buying life insurance can be an inexpensive way to replace assets that have been given to charity during your lifetime or to pay for estate taxes due by your heirs upon your death. When buying a policy to cover estate taxes you should not be the owner of the policy because it increases your taxable estate. A trust should be set up for the policy which removes it from your estate, giving full use of the policy for estate tax payments.
A trust for life insurance polices is called and ILIT and will be outlined below.
6. The last part of this section concentrates on how to remove assets from your taxable estate.
One of the best ways to reduce your estate tax is to reduce your taxable estate before you die. Some of the most commonly used strategies to remove assets from estates are explained below.
7. Irrevocable Life Insurance Trusts.
Also known as the ILIT, this method is used to remove your life insurance policy from your taxable estate. Because Life Insurance Polices are usually worth large amounts of cash, the removal of them from your taxable estate can greatly reduce your tax liability.
The method is one in which you make the ILIT the owner of the policy. The trust owns the policy and as long as the trust is created for three years with the policy in it, the death benefits are not included in your estate and thus not taxable for estate tax purposes.
The ILIT can also be the beneficiary of the policy giving one the ability to keep the proceeds in the trust for years to come, with distributions to spouses, children and loved ones at certain intervals. This can guarantee the assets will not be spent irresponsibly and protect the assets from creditors as well.
8. Tax Free Gifts.
Tax Free gifts are allowed by the federal government at a rate of $11,000.00 ($22,000.00 if married) to an unlimited number of persons. By giving $11K to 10 grandchildren each year your taxable estate is reduced by $110K per year, and twice that amount if a spouse joins you. One can also give to charities in an unlimited amount. Gifts for tuition and medical expenses are also tax free if given directly to the institution.
9. Qualified Personal Residence Trust (QPRT)
A QPRT lets you remove your home from your estate, by doing this many people remove one of the largest assets available from their estates. Under a QPRT you may also live in the home as well.
Basically the home is transferred to the QPRT and you continue to live in it. The QPRT is only good for a period of time, 10 or 15 years usually. During that time period you continue to live in the home and at the end of the term the home passes to the beneficiary of the trust. The beneficiarys are usually your children or other loved ones whom you can then agree with to stay longer or pay them rent.
A QPRT also functions as an important source to increase your estate tax exemption. The IRS allows the value of a residence in a QPRT to be reduced on their records. So if you put your home which is worth $500,000.00 in a QPRT your value for tax purposes could be as little as $200,000.00.
10. A Charitable Remainder Trust
A Charitable Remainder Trust allows one to use appreciated assets such as Investment Property and Stocks for purposes of creating a trust which will produce income. Such trust will also let you reduce your income taxes and benefit the charity of your choice.
The CRT is an irrevocable trust in which you transfer your highly appreciated assets and remove them from your taxable estate. You also receive an immediate income tax deduction for donating to charity. The trust then sells the asset paying no capital gains tax and reinvests the asset into more income producing assets. The trust then pays you the income from the investments. The income paid is one not reduced by capital gains so you will receive more income over the life of the Charitable Remainder Trust than if you sold the assets outright. After your death the beneficiary interest goes the charity of your choice.
11. Charitable Lead Trust.
Similar to the Charitable Remainder Trust the CLT works in an opposite manner. The assets are transferred to the trust reducing the size of your estate and saving estate taxes. The income off of the investment is then paid to the charity of your choice for a set number of years or until your death. Upon your death the assets will be transferred to your beneficiaries.
12. Grantor Retained Annuity Trust and Unitrust
Also known as at GRAT or GRUT, these types of trusts allow one to transfer income producing assets, such as stock, real property and business interests, to a trust for a fixed period of time (usually a number of years). The assets will then be removed from your estate and you will still receive the income.
Upon the end of the trust the assets will go to your children, spouse or other beneficiaries. The term GRAT or Grantor Retained Annuity Trust is used to describe a trust where the income you are receiving is fixed and a GRUT or Grantor Retained Unitrust is used to describe a trust where the income you receive will fluctuate.
13. Family Limited Partnership or FLP
The family limited partnership is one where you can transfer assets to your children now and still keep total control through what are called Managing Interests. So you transfer assets like a business, real estate, stock, or other investment property to the FLP and in turn you receive ownership interest in the property. Your children also receive ownership interest and the trust is set up so that you may still manage the property. By doing this the property is transferred from your taxable estate and your ownership interest cannot be sold or transferred without your approval. In essence you can transfer the assets to your children, still keep control, and remove the assets from your estate making your taxable estate much smaller.
