Using Deductions to Reduce Estate Taxes

The most successful estate planning allows you to give your assets to those you love without incurring a huge estate tax debt. When seeking ways to plan effectively, it is important to remember that all of your assets need to be included in your estate.

Like other financial planning you undertake, it is always wise to consult with a professional estate planner or attorney. Those interested in locating a qualified attorney in their area can visit the American Bar Association's website (www.abanet.org).

Keep in mind that while you can plan to minimize the amount of taxes you will pay, in some cases, you will still be required to pay some federal estate tax, state tax, or inheritance tax, and should plan accordingly. Exploring the rules and regulations governing estate taxes can be done by visiting the website of the Internal Revenue Services (IRS) at www.IRS.gov.

Assessing Your Estate
Adding up the value of your assets can be an eye-opening experience, even for those who think what they own is too little to worry about. When you include your home (including summer home, time shares, or other real estate holdings), financial investments (such as stocks, bonds, and cash), retirement savings (pensions and IRAs), and the value of life insurance policies, you may be surprised at the size and value of your estate, even in these tough economic times.

Minimizing Your Estate Tax
There are a number of tools and methods anyone can employ to minimize the amount of federal taxes paid. Five key deductions that are available to reduce the amount of estate tax paid include: (1) giving assets away during your lifetime, (2) making use of the marital deduction, (3) using a bypass or credit shelter trust, (4) making charitable donations, and (5) employing a life insurance trust. Each of these methods, when properly applied, will help minimize the amount of estate tax owed.

Giving Assets Away in Your Lifetime
The easiest method of reducing the size of your estate tax debt is to give the money away while you are still living. Federal tax law allows each individual to give up to $12,000 per year to anyone without paying gift taxes.

This is an easy way to transfer your wealth to your children or other friends or family members during your lifetime to reduce your taxable estate. Each spouse can give this $12,000 amount, doubling the amount that can be given to a family member or single individual so designated. And you can give this $12,000 amount to as many individuals as you like. (Note that the current $12,000 annual amount is not a static amount, but is instead reviewed by the government periodically and adjusted for inflation.)

Gifts of more than $12,000 can be given, of course, but amounts in excess of this figure will count against the amount shielded from tax by your applicable credit, so it is wiser to begin giving the money away in smaller amounts at an earlier date.

Making Use of the Marital Deduction
Unlimited amounts of your assets may be transferred to your spouse (while you are alive) without any gift or estate taxes. This method does have drawbacks, however, as marital deductions may increase the total combined federal tax on the estate of the spouses with the death of the subsequent spouse.

Using a Bypass or Credit Shelter Trust
With a bypass or credit shelter trust, if one of the spouses dies, the deceased can leave half the couple's assets shielded by the applicable credit to a trust. This allows the remaining spouse to use the income as needed while alive without putting those assets under taxation. The ultimate beneficiaries (such as the children, who will receive the parents' remaining estate) will be free of the tax burden, should the entire estate be transferred to the spouse upon death.

The surviving spouse's estate will be smaller (thus incurring less estate tax), and the couple would be able to pass along more of the estate to their children without tax penalty.

Making Charitable Donations
Any donations made to an organization that operates for "religious, charitable, or educational purposes" as defined by the IRS is not taxed. It is important to verify the eligibility of the organization before donating. As an added benefit, you may also be eligible for a tax deduction for your contribution (as may your estate).

Employing a Life Insurance Trust
The greatest benefit of a life insurance trust is that it keeps the life insurance policy out of your estate. It also provides liquidity for your beneficiaries. In general, you must either transfer an existing policy (which may have gift tax consequences) or buy a new policy. These trusts must be irrevocable to qualify, so be certain that you will not wish to access this asset later. With good planning, this income will go to your beneficiaries without the consequence of estate tax, a real benefit for them. This would provide ready cash that can then be used to pay estate taxes, your outstanding debts, or funeral costs.

While planning to minimize estate taxes is complex at times, and subject to changing provisions of the law, most individuals can undertake some or all of these steps to reduce the amount of estate tax that would otherwise be required. The planning that you undertake today is likely to result in more money for your beneficiaries over the long run, and that's a great benefit.