Checking your estate plan to increase family wealth

Downloads for Estate Planning

Each year the Congress passes new laws, the IRS issues new rulings, etc. all of which affects your estate plan. Checking your estate plan yearly is a good idea to retain the benefits of your planning and to take advantage of new opportunities. The various tax changes last year brought forth diverse and complex tax law changes that may impact a number of areas within a person's financial plan. Estate planning is primarily about controlling personal assets while passing them to heirs in the most efficient manner possible, however most people would associate this solely with not paying or minimizing the estate tax. For this very reason, it may be beneficial for an individual to review their estate plan currently in place to insure they are able to fully take advantage of all of the tax law changes.

One of the most significant changes within the tax law was the increase in the amount of assets each person can transfer free of estate and gift tax and the ultimate repeal of the estate tax for one year in 2010. This exemption is currently $1,500,000 and will gradually increase to $3.5 million in 2009. The exemption equivalent will increase in the following manner: $2,000,000 in 2006 through 2008, and $3,500,000 in 2009. This will effectively increase the amount of assets an individual can pass on to his/her family or others without exposing assets to an estate or gift tax.

Given these changes, there are several areas within your current estate plan that may be reviewed in order to take full advantage. One such area involves the area of gifting. By utilizing both the gift and estate tax lifetime "applicable exclusion amount" and the $10,000 per recipient annual gift tax exclusion, an individual may sharply reduce any potential estate tax liability. Also, for those individuals that have authorized a trusted individual to carry out their gifting program, the documents in place should be reviewed in light of the new law. An example would be a power of attorney. If you have a power of attorney in place that authorizes a trusted agent to continue your gifting program, make sure it allows the agent to take full advantage of the changes within the new tax law.

Gifting allows an individual to transfer assets from their estate to their heirs while they are still alive. For most individuals, however, the transfer of assets to their heirs will take place at their death. The document that facilitates this transfer is a will and, thus, another area that should be reviewed. Wills are commonly used to direct an estate plan. The will is the document that determines what amount of assets are exposed to an estate tax to fully take advantage of the unified credit exemption amount.

For example, Mr. Jones' will may read that upon his death, expose sufficient assets to estate taxes covered by the credit without incurring an estate tax due with the extra left to his wife. This is possible by exposing $1,000,000 worth of assets to the estate tax and, therefore, fully utilizing the exemption afforded each individual upon their death. A problem may arise if the will specifically quantifies the amount of assets as $1,000,000. This amount may be wrong because the exemption is going to increase. This individual's estate may miss out on up to hundreds of thousands of dollars in tax protection. Instead of quantifying a specific dollar amount in your will, it could be changed to incorporate formula language. Formula language will allow an individual, upon their death, to fully take advantage of the unified credit exemption amount no matter when they die.

A common substitute for a will that many people opt for is the living trust. The living trust not only serves the same function as the will but may provide additional benefits such as professional management of assets along with circumvention of the probate process upon death. But keep in mind that assets held in a revocable living trust remain subject to estate tax just like assets that pass by will. Therefore, a living trust should be reviewed in the same manner as a will. For more on Living trusts click here

For our example, let's look at Jack, age 60, and Diane, age 58 and their four children Karen, age 39, and Ken, age 32, who are their "business children" and Kerry, age 35 and Katherine, age 29, who are not (as well as 6 grandchildren). Jack's estate plan was completed and they want to treat all the children equally. The key to the plan was a sale for $2.5 million of 49% of Jack's stock in his business, Entrepreneur Corp., a subchapter C corporation, to his two business children (Ken and Karen). Jack would keep 51% of the stock in order to maintain control. Jack's basic estate was worth $8.5 million and it was felt that the $2.5 million was a fair price. In addition, Jack has $3 million in insurance on his life (with Diane as the beneficiary) and $800,000 in a rollover IRA.

This way, if Jack got hit by a bus tomorrow, his total estate would be $12.3 million ($8.5 million, plus $3 million, plus $800,000). The final combined estimated tax (capital gains tax on the sale of Entrepreneur Corp. stock to Ken and Karen, income tax on the rollover IRA and estate tax) would total an incredible $6.1 million. The family would get $6.2 million

The following is a better three part plan designed for Jack:

Entrepreneur Corp. subchapter S corporation status was elected. Voting and nonvoting stock was created - Jack keeps all the voting stock (1% of the total stock) to maintain control. The balance of the stock, 99%, all the nonvoting stock, was sold to a defective trust (with Ken and Karen as the beneficiaries) for $6.2 million. All of these are tax-free transactions.

We used these funds to create a sub trust to purchase $4.5 million of second-to-die life insurance (on Jack and Diane's lives), which will be free of income tax and estate tax when Jack and Diane pass on. We eliminated the $3 million of insurance on Jack's life and Jack pocketed the policy's $400,000 cash surrender value (tax-free).

For Jack and Diane's other assets: real estate, stocks and bonds, a Family Limited Partnership (FLIP) was created. The nonvoting shares of the Family Limited Partnership will be gifted to Jack and Diane's four kids and six grandchildren at the rate of $22,000 each per year. (Note: All Jack's other assets, except his residence worth $500,000, were transferred to the Family Limited Partnership, tax-free).

If Jack and Diane got hit by that bus tomorrow, their estate would rise to $14.2 million (Entrepreneur Corp. at $5.1 million, plus the other assets of $3.4 million, plus the IRA at $0.8 million equals $9.3 million; next, add the $400,000 of the cash surrender value which was transferred to the Family Limited Partnership, and the new second-to-die policy of $4.5 million in the sub trust and you have the final new $14.2 million estate total). The use of the Family Limited Partnership, the sub trust and the elimination of the capital gains tax cut the total tax on the estate total down to $4.5 million (from $6.1 million). The net amount to Jack and Diane's family mushrooms to $10.1 million ($14.2 million, less $4.1 million). Under the old plan, the family would have received only $6.2 million.

But there was more to this tax-saving program.

Before electing S corporation status, Entrepreneur Corp. paid a one-time, long-term care insurance premium for Jack, Ken, Karen and their wives. Entrepreneur Corp. was able to deduct 100% of the premiums. Now, all six members of the family will have long-term care benefits, with no additional cost, for the rest of their lives. A new twist in the long-term care tax law allows Jack and his family to not only get their long-term care completely free, but to actually make a profit. Jack, Ken and Karen will save a total of about $15,000 per year in payroll taxes.

A buy-sell agreement makes sure none of the stock in Entrepreneur Co could ever wind up in the hands of their kids' spouses should one or more of them get divorced.

A plan was implemented that will pay for the education of Jack and Diane's six grandchildren and provide for their retirement. The benefits for each grandchild will exceed $4 million (or about $25 million for all six grandkids). The average cost per grandchild will be $220,000 (paid over 10 years). Or put another way, $220,000 will return more than $4 million (all of it tax-free).

All of this (the Estate Planning, IRA Rollover, subchapter S corporation, second-to-die insurance, family limited partnership, Long Term Care Insurance, defective trust, etc.) can be done at Advanced Corporate Planning. Our Financial Planning, Estate Planning, Retirement Planning, Tax Planning expertise is here to save you and your estate from over-paying in taxes and our investment guidance in stocks, bonds, mutual funds, etc. are designed to maximize your returns. Contact us (click here) for full details on how we can enhance your estate's value - the sooner you start the more you save.

Of course, this brief article is no substitute for a careful examination of all of the advantages and disadvantages of this matter in light of your unique personal financial circumstances. Before implementing an estate planning strategy, contact and consult with your Financial Advisor, estate attorney and tax professional.