Tax Strategies for use in Estate Planning

Tax laws change frequently, and the estate tax laws have been particularly volatile over the last decade. Completely phased out in 2010, the estate tax was supposed to return in 2011, but recent negotiations have perhaps extended the reduced estate tax for the near future. Nevertheless, careful estate planning will allow an individual to maximize the extent that accumulated wealth will be used in accordance with his or her wishes after death instead of being transferred to the state.

The first strategy for estate planning is to make use of the marital deduction. If a spouse dies, any transfer to the surviving spouse is made without estate tax being taken out. As long as that surviving spouse remains alive, the estate remains untouched. You can also establish a trust to allow both spouses to make use of their normal estate tax exclusion instead of passing all assets to one spouse through the marital deduction and then being taxed on the death of the second spouse. A tax and estate planning attorney can help establish this “credit saving trust”.

Speaking of trusts, a living trust allows for transfer of assets while alive that prevents that portion of the estate from going through probate. The disadvantage of such a trust, called an inter vivos trust, is that the individual loses much of the direct control of that portion of the estate. But a well designed trust can overcome some of that loss of control while still transferring assets to an entity that will outlive the individual and thus not be part of the estate.

A major tool used by many to plan for their estate is life insurance. If the ownership of life insurance is properly arranged, it is not part of the estate at death and therefore would not be taxed. But the ownership rules are complex, and once again the use of a trust, called an individual life insurance trust, makes the process more effective.

Finally, aggressive use of annual gifting allows at least some of the bite of the estate tax to be avoided. Large gifts trigger a “gift tax”, but there is an exclusion per recipient per year, currently at $11,000, but it will be adjusted up over time. Any gift up to that amount is untaxed, and because it passes to the recipient now it is not included in the estate upon death. Aggressive use of the gift, giving the maximum to as many recipients as possible, can help avoid taxation on that amount in future years through operation of the estate tax. By carefully considering which items to give, and combined once again with the use of trusts to retain some control over the way that the gift can be used, assets can pass from one generation to later ones with less dilution through taxation.

All of these strategies require some very careful legal review to ensure that the intended effect will be had. Setting up trusts, structuring the ownership of life insurance, and making excluded gifts should only be done after consulting with a qualified estate planning attorney. But the small investment made in that consultation will likely result in significant savings when an estate passes to future generations.