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minimizing estate tax requires planning

By Sandy John


Tim Couch, a CPA who runs a tax-planning practice in metro Atlanta, says he sees it often: clients who will claim every tiny deduction on their annual tax return, but who won't sit down and do the planning that will minimize the ultimate tax bite -- estate taxes.

"The big savings really is in estate tax planning," said Couch, of Couch & Associates in Duluth, GA. "It's difficult to make people understand why estate planning is so important." Perhaps they are reluctant to think about dying, or simply don't realize how much of their estate can be eaten by taxes.

Your estate includes not only your home and other personal property and investments, but also money you have in pension plans including 401(k)s and IRAs, as well as the value of any life insurance and annuities you own. Under current tax law, taxes on estates valued at more than $1 million start at 41 percent and go up to 55 percent. So, if you were to die in 2002 with an estate valued at $2 million, and you'd done nothing to minimize taxes, your estate could owe $435,000 in taxes. (The exemption is scheduled to rise in phases to $3.5 million in 2009, with estate taxes eliminated in 2010; but most observers believe we can count on another tax law revision before the end of the decade.)

Estate planning is a complex issue that should be completed with the help of a specialist in the subject. Couch outlined a few popular strategies an estate professional might suggest:

 Credit shelter trusts: The good news is, when you die you can pass all your assets on to your spouse without incurring estate taxes. The bad news is, when the second spouse dies, those inherited assets, along with the second spouse's own assets, are subject to the $1 million exemption, not $1 million for each partner. To allow the couple's heirs to take advantage of the $1 million exemption for each partner, the first spouse to die can leave assets up to $1 million to a credit shelter trust. The surviving spouse gets all the income from the trust until death, when the trust's assets can be passed on to children or other beneficiaries tax-free. The second spouse to die will also be able to pass along up to $1 million of assets not in the trust, tax-free.
 Gifting: An obvious way to lower estate taxes is to die with a smaller estate. And you are free to give the money away before you die, with certain limits, of course. In fact, you can give -- to anyone you want, and to as many people as you want -- $11,000 per person a year, without incurring the gift tax. For example, if you have two children and four grandchildren, you and your spouse can both give them $11,000 apiece, for a total of $22,000 annually, for as many years as you want, reducing your estate by $132,000 with each year's gift-giving to the six recipients.
 Family limited partnership: By putting your assets into a limited partnership and naming yourself as general partner, you're able to take gifting a step further. Because the limited shares are not marketable, the appraised value of the shares would be discounted from the value of the underlying assets. The discounted value of the shares allows you to give your heirs $11,000 worth of shares annually without triggering the gift tax, even though the shares represent more than $11,000 in assets. That allows you to give away a bigger chunk of your estate annually, so a smaller estate will be left when you die. If you die before you've given away all the limited shares, the estate will benefit from the discounted value of those shares compared to the actual value of the assets.
 Insurance for liquidity: Estate planning can help minimize the estate tax bite, but not necessarily eliminate taxes. Smart estate planning requires you to provide your heirs with a means to pay the estate taxes, which will be due nine months after your death. "If your assets are not liquid -- if, for example, they are tied up in real estate or a family business -- the heirs may have difficulty raising the money in nine months," Couch noted. The answer is a life insurance policy with a death benefit large enough to cover the estate taxes.


There is one catch in having insurance to cover the taxes, however: If the person who is covered by the policy is also the owner, the insurance is counted as part of the estate (increasing estate taxes in the process). So, instead of owning the insurance yourself, the policy should be owned by an adult child or by a life insurance trust you set up. The cost of insurance to cover the estate tax may seem like a large expense, Couch added, but as long as the cost is less than the estate tax, you've saved money. "The premium might be a big check, but it's still less than the $1 million you might owe in estate taxes," he said.

A tax- or estate-planning professional can suggest other appropriate strategies or options for minimizing estate taxes. If you did estate planning before the latest tax law took effect, ask your planner whether you should alter your plans to take advantage of new laws.

 

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