Not too long ago, tax minimization or avoidance was a motivating factor for large numbers of people to engage in estate planning. Just 15 years ago, a 55% estate tax kicked in for estates worth just $675,000, an amount that many families could easily exceed once they added life insurance benefits to their home equity and 401(k). And if you failed to use that exemption amount, by, for instance, passing your estate to your spouse instead of other beneficiaries, your surviving spouse wouldn’t be able to tack your unused portion to their exemption. It would simply be lost.

Not so much anymore. Today, the estate tax exemption stands at $5.45 million per person, and this amount will automatically adjust upward each year to account for inflation. Perhaps more importantly for planning purposes, married couples can combine their exemptions and give away $10.9 million before having to worry about estate taxes. Moreover, the estate tax rate has been lowered to 40%. Still a lot, but for comparison, whereas a $15 million estate may have paid nearly $8 million in taxes in 1999, today it would pay “only” $1.64 million, even without any planning.

Still, even with the much higher amounts, there are people out there lucky enough to have this problem. If you’re one of them, here are some estate tax minimization strategies to consider.

Lifetime Gifting

The estate tax threshold isn’t just about what you can give away after you have died. It includes gifts you have made during your lifetime. You can imagine why. If you were allowed to give away unlimited gifts during your lifetime, most people would probably try to wait until the last possible minute and give away everything on their death bed. Sorry, but the IRS has already thought of this possibility.

Of course, the IRS doesn’t want to know about every gift exchanged across the country every year. The resources needed to track that level of detail would be overwhelming. They do, therefore, allow you to give away a certain amount of money each year (currently $14,000) before you have to report the gift on a gift tax return. This does not result in a tax being due right then, but after you pass away, the amounts you have reported on the gift tax returns will be deducted from the amount you can give away before the estate tax kicks in. Note, however, that the gift tax exemption is per person, meaning that if you and your spouse have two kids, you each can give each of them $14,000, meaning that you could give your kids a combined $56,000 before having to report a tax. And you can double that if your kids are married to spouses that you like and trust. And then you can give away even more by adding grandkids into the mix. The liberal rules surrounding gifting can make it a very easy and very effective way to address a complicated problem.

You should talk to professional tax and legal advisors before undertaking any of the strategies described in this post, but the other strategies discussed below are complicated enough that it probably isn’t even a possibility to do it on your own. Gifting, on the other hand, may seem easy enough to do without professional help. Don’t be fooled. Different asset types come with different rules about how they need to be valued at the time of the gifting. Moreover, there are significant tax advantages to be gained by passing certain assets along at death, most notably, a step up in capital gains basis, that will be missed if you instead gift the asset during your lifetime. Finally, for a distribution to truly count as a gift, the person receiving the gift really does have to have the right to use that gift as they please right away. You may not want to give tens of thousands of dollars to your 24 year old, without any strings attached. Gifting done wrong can backfire badly.

Inter-Family Loans

$14,000 per year may sound like a lot of money, but there can be occasions where you do want to give more. For example, maybe you want to help a child with a down payment on a house. Are you stuck dripping that gift out over years? Or filing a gift tax return? Not necessarily. You could loan the money to your child and then gift the interest and principal back to the child over the subsequent years. Again, while this may sound relatively straightforward, you should still avail yourself of professional advice before proceeding with this plan. An inter-family loan needs to be well documented, with a note and payment records, to ensure the existence of the loan can be proved to the IRS if needed. Also, the IRS requires a minimum interest rate, which changes month-to-month and varies based on the length of the loan.

Family Limited Partnership or Family LLC (FLP or FLLC)

The problem with both lifetime gifting and inter-family loans is that they result in a total loss of control over the assets by the person making the loan or gift. You can advise your children how you want them to spend the money, and withhold future payments if they fail to abide by those instructions. But the defining feature of a gift or loan is the recipient’s ability to use it as he or she sees fit. If you’re still controlling it, it wasn’t a gift or loan, meaning that it’s still yours, will still be part of your estate, and will still count towards the total value of gifts you have given, potentially pushing you back over the tax threshold, despite your best efforts.

A popular way to remove assets from your estate while still retaining control over them during your lifetime and ensuring that they ultimately make their way to your kids is with a family limited partnership. A limited partnership allows people to form a business partnership together, while limiting the liability that each partner could potentially incur if the partnership gets sued. There are a lot of ways to set this up. The selection of who, or what entity, will serve as the general partner is probably the most critical decision, because that person (or entity) is on the hook for the partnership’s liabilities.

Once the partnership is set up, the older (and presumably, wealthier) generation can transfer assets into it, and out of their estates, but then continue to control those assets by controlling the partnership. They can gift non-controlling partnership interests to their kids (or a trust set up for their benefit). One of the greatest benefits to making the transfer this way is that, because the owner of the transferred interest doesn’t actually have any control over the partnership’s operations, their market value is greatly reduced, increasing the size and number of assets that can be transferred each year.

So why shouldn’t everyone set one of these up? First of all, the documentation surrounding the establishment of a family partnership is complex and requires top notch advice from both legal and tax professionals, and maybe an insurance professional and financial advisor. It’s neither cheap nor quick. Moreover, the ongoing maintenance, bookkeeping, and documentation required to keep the partnership up to IRS standards year after year can be daunting. It’s needs to be treated as what it supposedly is — a distinct entity, with an identity separate from the members of the family. That means it needs to have its own files, its own books, its own bank accounts and its own tax returns. The discipline needed to keep doing this years after the initial excitement has worn off can be considerable. Sorry, but if lowering taxes and protecting assets from creditors were cheap and easy, everyone would do it.

Qualified Personal Residence Trust (QPRT)

A Qualified Personal Residence Trust (a “QPRT,” pronounced “queue-pert”) provides a way for a person with an estate that is large enough to be taxable a way to transfer a residence to their heirs outside the estate. The way it works is that the trustmaker transfers the property into the QPRT for a certain number of years. Depending on current interest rates, the age of the trustmaker, and the number of years that the house will spend in the trust, the value of the home will be reduced for gift tax purposes. The older the trustmaker, the longer the term of the trust, and the higher the interest rates, the better, because all will lead to a lower gift valuation. Note, however, that if the trustmaker fails to outlive the trust, then the house goes back into his or her estate at its full value, potentially resulting in (higher) estate taxes. During the term of the trust, the trustmaker can continue living in the property, rent-free. At the end of the term, however, the property transfers to the trust beneficiaries, either directly or through another planning vehicle. At that point, the trustmaker can continue living in the property, but will need to pay fair-market rent to the new owner(s).

QPRTs are a fairly low risk estate tax avoidance technique. But one thing to watch out for is capital gains tax. Because the residence is being transferred as a gift, the people who receive it will take it with the trustmaker’s capital basis. When you receive property from someone as part of their estate, on the other hand, the capital gains basis is stepped up to the value of the property at the original owner’s death. The loss of this step up in basis may undo the tax benefits that were obtained by avoiding estate tax.

Grantor Retained Annuity Trust (GRAT)

A Grantor Retained Annuity Trust (a GRAT, and its close cousin, the Grantor Retained Unitrust, or GRUT) can give you a way to move assets out of your estate, continue receiving income from them for a certain period of time, and then transfer those assets to the trust’s beneficiaries, tax free. To accomplish this, you set up an irrevocable trust, sell the assets to the trust, and specify how long you want to receive income from the trust. The IRS specifies how large the annuity must be, based on the amount of time you want the trust to last. For this strategy to work, you need to put assets in the trust that will grow faster than the IRS’s assumed rate. Otherwise, there won’t be anything left at the end of the trust’s term for the beneficiaries to receive.

There are several notable risks involved with transferring wealth using a GRAT. First, if you die before end of the GRAT’s term, all the property that you had placed in the GRAT goes back into your estate. So although you may be tempted to put a large amount of assets into the GRAT and receive annuities for a long period of time, doing so increases the risk that the GRAT will not accomplish anything.

The second risk is that if the assets in the GRAT fail to appreciate faster than the minimum annuity required by the IRS, there won’t be anything left in the trust by the time it expires.

Finally, although the purpose of creating a GRAT is to avoid gift taxes, there are several other potential tax implications. For one, as the grantor of the trust, you will be required to pay taxes on income earned by the trust. Currently, income earned inside of a trust gets taxed at the highest rate at just $12,300 of income. Also, if trust funds end up going to a person more than one generation below you, generation skipping taxes may be due.

Intentionally Defective Grantor Trust (IDGT)

An Intentionally Defective Grantor Trust (an IDGT, pronounced “id-jit”) offers a way to remove assets from your estate, thereby reducing or eliminating your estate tax, and gift funds to your beneficiaries without having to pay gift tax. The grantor (the person who who is creating the trust to avoid taxes) accomplishes this by selling an asset that is expected to grow in value to the trust in exchange for a note that will pay above-market interest. The grantor will pay income tax on that interest. But because the asset has been irrevocably committed to being transferred to the beneficiaries, it is considered a completed gift for estate tax purposes. That means it won’t be counted as being part of the grantor’s estate when determining the estate’s tax liability. This arrangement also enables the grantor to continue controlling the asset while he or she is alive, even though the asset has been irrevocably pledged to be given to the trust beneficiaries.

Irrevocable Life Insurance Trust (ILIT)

Please take note: Although the recipient of life insurance death benefits is not required to pay federal income tax on those benefits (but check your state’s tax laws), those benefits will be included in your estate when determining whether it owes estate taxes. This means that, although your personal net worth may not put you above the estate tax threshold, your life insurance benefits can get you there. There is, however, a way to prevent those benefits from being included in your net worth. Rather than holding the life insurance policy yourself, you put the policy into an irrevocable life insurance trust (an ILIT, pronounced “eye-lit”). In other words, the trust owns the policy instead of you, and receives the death benefit after your passing. The trust beneficiaries then receive those funds according to the instructions you leave in the trust agreement.

One thing to watch out for with ILITs is that the premiums are counted as a gift from you to the trust beneficiaries in the year that they are paid. And so let’s say the premium is $30,000 per year and you have two kids. Currently, you’re only allowed to give up to $28,o00 to those kids before having to file a gift tax return. That premium payment alone would put you over that threshold every year. And you will probably give other gifts to those kids over the course of the year too.

Also, for these premiums to truly count as a gift to the trust beneficiaries (a requirement for the trust to count as an ILIT), the trust beneficiaries need to be given an opportunity to pull the money that is put into the trust out at the time it is deposited (and they need to be reminded that they have this right in writing every year). In most cases, pulling out the money that is meant for a premium payment, thereby causing the policy to lapse, would be a phenomenally stupid thing to do. But there are phenomenally stupid people out there, and if your kids are among them, you will need to plan accordingly.

Finally, as with the other trust-based strategies on this list, this trust is irrevocable. You can’t change the instructions in the trust about who is going to get what after you pass away. Of course, you could simply stop paying the premium and allow the policy to lapse, but depending on what type of policy it is, that could result in a significant or total loss of money that had been put into the trust up until then.

Charitable Remainder Unitrust (CRUT)

A Charitable Remainder Unitrust (a “CRUT”) allows you to accomplish three goals: (1) remove assets from your estate, thereby lowering its potential tax liability; (2) provide lifetime income to you or your beneficiaries; and (3) make a significant contribution to a favorite charity. The way it works is that you put a highly appreciated asset into an irrevocable trust. The placement of the asset into trust allows you to deduct its value from your income in the year of the donation. You also will avoid capital gains taxes on the sale of the asset later on. After placing the asset into trust, you then specify the length of time you would like for the assets to be held in trust. This could be for a specific number of years, or for your or your beneficiaries’ lifetimes. During the time that the assets are held in the trust, a percentage of the trust’s value can be distributed to you or your beneficiaries. At the end of the trust’s term, the remaining assets are distributed to the charity that you chose at the time of the trust’s creation.

There are several different ways to set up the calculation and timing of income, and you will want to carefully consider what you are trying to accomplish when formulating your plan with your attorney.

Charitable Lead Annuity Trust (CLAT)

A Charitable Lead Annuity Trust (a “CLAT”) is effectively the opposite of a CRUT. Rather than giving the trust income to your beneficiaries and the remainder of the trust to a charity, a CLAT results in income to a charity for a certain period of time, and then whatever is left at the end of the trust’s term going to your chosen beneficiaries. Unlike with a CRUT, placing assets into a CLAT does not result in the donor being able to take an income tax deduction at the time of donation. The value of the gift that will ultimately go to your beneficiaries, however, and the amount that may need to be reported on a gift tax return, will be lower than the gift’s face value, due to the time those beneficiaries will have to wait to actually receive the gift. The IRS estimates the likely value of this gift based on interest rates at the time the asset is placed into trust. If the trust assets grow faster than the IRS’s projected return, your beneficiaries will end up with more than what you may have expected (of course, the opposite — underperformance leading to less than expected — is also a possibility). The beneficiaries of the trust receive whatever amount is left in the trust at the end of its term without any tax consequences.

As with CRUTs, there are several important decisions that need to be made when setting up a CLAT that will make a substantial difference to the amount of


This is just a sampling of some of the most popular ways to address a potential estate tax problem. It is not a comprehensive list of every option out there, and even within these options, there are several decisions that need to be made that will dramatically impact their riskiness and effectiveness. A point to note about all of these options, however, is that they typically take time, usually at least a few years, to properly carry out. For fairly obvious reasons, the IRS does not make it easy to put this off until the last minute and then avoid a bunch of taxes. Hard decisions have to be made, and the sooner, the better.

If your assets and insurance benefits might be enough to put you over the estate tax threshold, it is important that you assess the potential consequences for your estate and plan accordingly. Even if you ultimately decide that avoiding taxes is more trouble than its worth, at least you will have made the decision knowledgably, and can advise the people who may be expecting to be your beneficiaries to plan accordingly.

Contact our office to discuss your options further.