Douglas A. Turner, P.C.

(updated December 9, 2007)

With the current federal estate tax exemption at two million dollars, fewer individuals are faced with federal estate taxes. However, for those with more than two million dollars in assets and life insurance, there are some simple and inexpensive techniques to greatly reduce if not eliminate any potential federal estate taxes.

Technique #1: Shelter $4.000,000 from Federal Estate Tax with a Colorado Living Trust Plan

Just about any married couple with substantial wealth should have “tax” planning wills or living trusts. The word “tax” is in quotes because this is really a “trust” planning will or living trust plan. The trusts set up at the death of the first spouse (1) protect up to two million dollars from federal estate tax, (2) provide asset protection for assets placed in the trusts and (3) insure that the surviving spouse passes the remaining trust assets to the agreed upon heirs. This last benefit is perhaps the most important. We see far more wealth being transferred to a new spouse, creditors and newfound “friends” than we see being paid in federal estate taxes.

Keep in mind that a married couple may have a combined exemption of four million dollars (two million dollars, each). However, without a tax planning will or living trust, half of the exemption will be wasted when the first spouse dies. With proper planning, four million dollars can be sheltered from federal estate tax.

Technique #2: Use A Limited Liability Limited Partnership (LLLP) for Asset Protection and Federal Estate Tax Reduction

Use limited liability limited partnerships for investments, real estate and vacation homes. A limited liability limited partnership or “LLLP” has a general partner who controls and directs the partnership and limited partners who have no control in the partnership operations. A LLLP also limits the personal liability of the general and limited partners. The general partner typically owns one percent of the LLLP assets. The limited partners own the remaining ninety-nine percent of the LLLP assets. A person can be both a general partner and a limited partner. When first created, the same person, the person with the wealth, owns most of the LLLP.

There are three primary benefits of using LLLPs for investments, real estate and vacation homes:

• First, using a Limited Liability Limited Partnership provides some asset protection.
• Second, using a Limited Liability Limited Partnership creates a structure for gifting assets at a later date without giving up total control.
• Third, the use of a LLLP can create the ability to discount the value of LLLP assets when it comes time to pay federal estate taxes. For example, a Colorado Limited Liability Limited Partnership holding ten million dollars in real estate may be discounted by twenty to forty percent for valuation purposes. Twenty percent of ten million dollars is two million, as in two million dollars not subject to federal estate tax. Assuming a federal estate tax rate of forty percent, the savings are substantial. At the low end of the discount spectrum, $800,000.00 in federal estate taxes can be avoided. At the high end of the discount spectrum, $1,600,000.00 in federal estate taxes can be avoided.

The IRS frowns upon using LLLPs for the sole purpose of obtaining valuation discounts at death. Many people have created LLLPs shortly before their death in an attempt to avoid federal estate taxes. Creating a LLLP shortly before death and claiming big discounts can be risky.

Technique #3: Use irrevocable trusts to hold life insurance and other assets.

Many people forget that life insurance an individual owns or controls is considered part of their taxable federal estate. A life insurance policy with a death benefit of one million dollars is subject to federal estate tax on the entire death benefit.

Life insurance is an easy asset to remove from a taxable estate. An irrevocable trust is created to hold the life insurance. Since the irrevocable trust is not owned or controlled by the insured, the death benefit is not considered part of his or her federal taxable estate. As an added benefit, the current value of the life insurance policy and the death benefit receive some asset protection.

Irrevocable trusts can be used to hold other assets besides life insurance. For example, limited partnership interests can be gifted to an irrevocable trust. The general partner retains control of the LLLP while value of the limited partnership interests is removed from the taxable estate.

Technique #4: Gifting As A Tool to Avoid Federal Estate Tax

The federal estate tax exemption is currently two million dollars. One million dollars of that exemption can be used during life by gifting assets. In an estate valued at ten million dollars, some of the assets will not produce much income although those assets may be appreciating in value. For example, a vacation home may not produce any current income and be appreciating in value.

Another example would be a collection of family heirlooms or perhaps a family farm. Gifting those assets to the ultimate heirs removes the appreciation from the taxable estate. The trick is removing the assets from the taxable estate while still retaining some control. Again, a LLLP is a good vehicle to accomplish this goal.

In addition to the one million dollar lifetime gift exclusion, an individual can give $12,000.00 per calendar year to anybody without paying gift tax. This is where techniques #2 and #3 can be leveraged.

Let’s assume that a wealthy parent has 2 adult children. Child #1 has 4 adult children and 10 grandchildren. Child #2 has 2 adult children and 5 grandchildren. In total, there are 23 individuals to whom the wealthy parent can make gifts. The annual exclusion for gifts is $12,000.00; however, that amount can be leveraged through valuation discounts by twenty to forty percent. Assuming a twenty percent discount, the $12,000.00 exemption can be leveraged into $14,400.00 per person. By combining outright gifts, gifts of limited partnership interests and gifts to irrevocable trusts, $331,200.00 can be gifted in any calendar year. If the date is December 31, 2006, over $660,000.00 can be gifted within two days without triggering any gift tax. At a forty percent estate tax rate, the savings to the family is over $264,000.00.