The right trust could cut estate taxes Tax Matters by David A. Katzman If you are like many people, you may think your estate is modest so it will not be impacted by estate taxes. However, your estate’s value may be larger than you anticipate—particularly if you own life insurance policies or your residence is of significant value. Federal estate taxes are variable, as well. For 2009, up to $3.5 million in assets may be transferred to heirs free of federal taxes. During 2010, the estate tax is repealed and unlimited assets may be transferred. Beginning January 1, 2011, however, just $1 million is exempt from estate taxes. Of course, all of these figures could change if current law changes. While a $1 million dollar exemption may seem adequate, this amount can easily be exceeded after proceeds from a life insurance policy and the value of a residence are included. However, there are ways to lower the value of your taxable estate through the establishment of a various trusts. For example, you may want to consider establishing an irrevocable life insurance trust. The trust becomes the owner and beneficiary of your life insurance policies. To make the premium payments, you contribute funds to the trust, which are used to pay the fees. A properly drafted trust should allow for the contributions to qualify for gift-tax exclusion, so gift taxes will not be owed. In addition to saving on taxes, this type of trust may protect your ultimate beneficiaries from asset loss from creditors or in the case of a divorce because these assets are protected from exposure to these events. Additionally, as long as the assets are held in the trust it is more likely that they will be professionally managed as you can choose the trustee. This may be helpful if your beneficiaries are not financially savvy. During your lifetime, life insurance trusts typically provide that any principal and income may be used for the benefit of your spouse or descendants, at the discretion of the trustee. This allows for access to the cash surrender value of a life insurance policy, if needed, and it also provides for the possibility of terminating the trust if it becomes necessary. Upon your death, your trust may provide rights to your surviving spouse, such as the right to ongoing income and some ability to gain access to the proceeds. When your spouse dies, the trust may be paid out in full to beneficiaries or the money may be held and paid to beneficiaries in accordance with your wishes. Another option, if your residence is of significant value, is a qualified personal residence trust (QPRT). In this type of trust, you transfer ownership of your residence to the trustee. In some cases, the trustee can be you. When properly drafted, this arrangement allows you to live in your home, rent free, for a specified number of years. Ideally, you should outlive this specified period. During this time, you continue to pay the ongoing costs of homeownership and you are allowed to take individual tax deductions, such as mortgage interest and property taxes. At the end of the specified term, your residence transfers to your children. However, distribution can be delayed until after your death and the death of your spouse. While you remain alive, but after the fixed term has expired, you lease the residence from your children and continue living in your home. The lease must be at full market value or you could trigger estate taxes upon your death. While the transfer of your residence to the trust will be still be considered a taxable gift, it is eligible for the $1 million gift-tax exclusion, so you may avoid paying most or all gift taxes. To further reduce the value of your residence, you are allowed to subtract the value of your right to live in the home for the fixed term. Either of these trust options offers ways to help your heirs avoid paying estate taxes, even if your estate exceeds the exemption amount. David A. Katzman is a certified public accountant licensed to practice in the State of Florida and the Commonwealth of Massachusetts. He is also a certified financial planner and certified senior advisor. Please consult your tax advisor for details and assistance in applying this general information to your specific situation.