Estate Tax Charitable Deduction

This is the final blog in the series on reducing gift and estate taxes. If your estate is larger than the estate tax exemption limit another good strategy is to give a portion to your favorite charity.

Beside doing something good for others you also do something good for you. The strategy is to do a split interest transfer where both the charity and you benefit.

Seven requirements must be met for a gift to be tax deductible:

1. Contribution must be made to a qualified charity
2. Property must be the subject of the gift
3. Contribution must be in excess of any value received in return by the donor
4. Must be paid within the tax year
5. The value, if over $5,000, must be attained through a qualified appraisal. An appraisal is not required for publicly held securities.
6. Contribution effective at death is deductible and transfer must be made by the decedent.
7. A split interest must be in the form of a trust.

This split interest trust comes in 2 forms. The first form is the Charitable Remainder Trust where you derive an annual benefit and the charity gets what is left. Secondly, is the Charitiable Lead Trust where the charity derives an annual benefit and your beneficiary get what is left.

A Charitable Remainder Trust is an irrevocable trust designed to provide a fixed amount annually to a non-charitable beneficiary, usually you the donor, with the remainder left to the charity. The annual amount must be somewhere between 5 % & 50% of the initial fair market value. Future additions to the trust are not allowed.

This works really well when a person has assets and needs more money to live. Instead of selling the asset and paying capital gains tax reducing your income, you donate the asset, increase your income through a tax deduction and you get paid an annual income. You can do something good for a charity, get an income tax deduction, have more money to live each year, and you do not have the hassle associated with disposing of the asset. A good deal for you and the charity.

A Charitable Lead Trust is an irrevocable trust design to do just the reverse. You transfer an asset's income interest for a period of time, get a tax deduction, and retain ownership of the asset. This works well for a person who has sufficient income and wants to reduce the value of the estate.

An example of how this works is a person donates $10,000,000 worth of securities that likely will appreciate with time and the charity gets 8% ($80,000) for 24 years. The value of this is calculated to be worth $9,600,000. At the end of the 24 years the trust still has a value of $10,000,000 even after the annual payments. The value of the trust from an estate tax perspective is $400,000, below the exemption limit and free of any estate tax.

This is a relatively complicated topic and professional assistance is required. It is wonderful that both you and your favorite charity can benefit so that your life can continue to have an impact into the future.

Estate Tax Marital Deduction

A major issue for retirees is avoiding paying estate tax especially if the estate tax exemption limit is reduced back to a level of $1,000,000 - $1,500,000. It may be easier than you think to reach a $1,000,000 estate especially for a married couple. Consider the value of your home, personal property, life insurance proceeds when a spouse dies, IRAs, Annuities, 401(k)s, and future inheritance from your parents and other family members.

Once you reach the exemption limit, your estate will pay at least 41% in tax to the government. As the size of the estate grows so does the tax rate and tax burden.

Married couples have an option to reduce the amount of estate tax called the unlimited marital deduction. A spouse can give the entire estate to a spouse without paying estate tax if 3 requirements are met:

1. The property left to the surviving spouse must be included in the gross estate of the first spouse to die.
2. The property must actually pass to the surviving spouse.
3. The property must not constitute a terminable interest when ultimately received by the surviving spouse.

Even with the unlimited marital deduction, paying of estate tax can not be avoided. Once the surviving spouse passes the estate tax is calculated.

To minimize the amount of estate tax liability a dual approach is often used. The estate is divided into 2 parts, an amount of the estate equal to the exemption limit is given to the surviving spouse and the remainder is put into a trust. In this manner, the number of exemptions can be increased from 1 to 2. Saving 45% on $1,000,000 means that $450,000 is given to an entity you choose rather than the government.

Options exist with the design of the trust. This is a complicated topic and getting professional assistance may be extremely beneficial.

An option to reducing estate tax is to take advantage of the charitable deduction. This is the topic for the next blog.

Gift and Estate Tax Planning

Congratulations you have been successful and have a large sum of assets. You have now entered the final stage in financial planning known as Estate Planning. It has 2 components, Gift Tax and Estate Tax reduction.

This is a very complicated topic that requires legal guidance. The blog will give an overview to get you on the road. You can avoid paying as much in taxes by taking a few steps.

TAX RATES

The Unified Federal Estate and Gift Tax Rates (1977 - 2009) for Taxable Transfers:

$1,000,000 - $1,250,000 = 41%
$1,250,000 - $1,500,000 = 43%
$1,500,000 - $2,000,000 = 45%

GIFT TAX EXEMPTION LIMIT

The gift tax exemption limit is $1,000,000. An amount less than $1,000,000 is not taxed. Gifts given to a recipient in a year worth less than $12,000 per person or $24,000 per couple are not reported and do not count toward this limit. Amounts above this limit must be reported and counted toward this exemption limit on IRS Form 709.

ESTATE TAX EXEMPTION LIMIT

For 2008, the estate tax exemption limit is $2,000,000. This limit increases to $3,500,000 for 2009. In 2010, the estate tax is repealed.

What happens to the exemption limit in 2011 and beyond? The answer is unknown. My belief is that given the current political environment that it could easily be reduced and could go back to the $1,000,000 level.

If the estate tax is repealed then no planning is required. If the exemption limit is reduced to $1,000,000, in an effort to raise taxes revenue and reduce the national debt, a considerable amount of planning may be requred. My strategy is to plan for the $1,000,000 limit and hope that the tax gets repealed.

Future blogs will discuss gift and estate tax reduction strategies.