How to Lower Your Estate Tax Liability on the Federal and State Levels

In early 2013, Congress clarified the estate tax landscape and made permanent certain provisions of estate tax law, such as the exemption from estate tax for the first $5.45 million of one’s estate, indexed annually for inflation. There has been no such clarity on the state levels, which remain a patchwork of different estate tax laws.

On the federal level, in addition to the exemption of $5.45 million each year indexed for inflation, the 40% estate tax rate is, for now, standard.  In addition, portability between spouses of an unused exemption is also now allowed.  Congress can change these laws in the future, as it has in the past.  In addition, in this election year, estate tax rates and exemptions are campaign topics and are subject to revision by a new administration.  However, at least for now, the federal estate tax regime is clear and as a result, we as tax practitioners have a better ability to plan for clients when the law is clear.

However, estate taxes on the state level are much more variable.  In New Jersey, the threshold for estate tax is only $675,000, the lowest in the U.S., and at a huge variance from the $5.45 million federal exemption.  The threshold in Connecticut is $2 million, cut from $3.5 million in 2011.  The threshold in New York is currently $3.125 million, will rise to $4.18 million on April 1, 2016 and to $5.25 million in 2017.  Ultimately, the NYS exemption will be at parity with the federal exemption amount in 2019.  In a significant quirk, a New York tax law anomaly known as “the cliff” sets the estate threshold to zero (i.e., no exemption from estate tax at all) if one’s estate is valued at $3,281,250 or more.  In other words, in New York, there is no estate tax for estates lower than $3.125 million and complete estate tax on the entirety of the estate, with no threshold and no exemption, for any New York estate valued in excess of $3,281,120.

Thus, depending on the value of one’s estate, and one’s residence, one’s estate may owe considerable state estate tax even if it is exempt from federal estate tax.

Some states have no estate tax and no income tax.  For this and other reasons (sunshine?) such states, which include Florida and Nevada, attract migration from high-tax states such as New York, New Jersey and Connecticut.

There are various strategies that one may utilize to lower one’s taxable estate on both federal and state levels.  Some of the strategies proven to reduce estate taxes are:

GRAT – If you contribute assets into a Grantor Retained Annuity Trust, you could receive a regular payment akin to an annuity over many years, and then when the trust term ends, the appreciated assets pass to your heirs, are not considered part of your estate and will not be subject to estate taxes.

QPRT – If you contribute your personal residence into a Qualified Personal Residence Trust, you may still live in the residence for a term of years, and when the trust term ends, the home is removed from your estate while passing to your heirs and will not be subject to estate taxes.

FLP – After contributing your assets into a Family Limited Partnership in return for general and limited partnership interests, you may then, over time, gift your limited partnership interests to your heirs while retaining the general partnership interest (thereby continuing to control the FLP), and thus remove the value of the limited partnership interests from your estate.  FLPs also provide the additional bonus of excellent asset protection.

CRUT – By contributing appreciated assets to a Charitable Remainder Unitrust, you are entitled to a charitable deduction, regular payments from the trust back to you during the trust term, and at the end of the term the assets pass to the charity, are not subject to income tax and are removed from your estate.

ILIT – If you own or control life insurance policies, the IRS deems their death benefit to be in your estate and subject to estate tax, even though you will never receive the death benefit during your life.  If you contribute these life insurance policies to an Irrevocable Life Insurance Trust, you may remove the insurance policies from your estate.  Your family members may receive the death benefit from the trust, free of any estate tax.

Dynasty Trust – Such a trust allows the preservation of assets for one’s immediate and remote descendants, along with offering asset protection from creditors, as well as delay of the estate tax bite for many generations.  The trust can distribute income to beneficiaries, but principal is preserved, asset-protected and grows tax-free.

These strategies are not only for the mega-wealthy.  We have successfully utilized these strategies for clients of means at various levels who are concerned with leaving as much of their hard-earned assets for their heirs with as little as possible going to the IRS and state tax authorities.  These are equally attainable goals with a $5 million estate as they are at $50 million.

Moreover, these strategies are affordable, especially considering the amount of tax savings they offer.

Of course, if you want to move to Florida or Nevada, go for it.  But if you’re considering a move for estate tax reasons, first consider these various strategies to lower your estate tax liability without having to relocate.


This article’s author is Kenneth Rubinstein

The Federal Reserve Board raised interest rates at the end of 2015 and predicted that it will continue to raise rates several times in 2016.  Affluent taxpayers need to review their estate planning strategies to determine what strategies should be implemented before interest rates rise and what strategies will be most advantageous after interest rates rise.

Before Interest Rates Rise:

The most advantageous estate planning strategy to consider during a low interest rate regime is the use of intra-family loans.  Parents may lend investment funds to children or grandchildren and they may also sell assets (e.g., equity in private businesses, real estate) to children or to trusts for the benefit of children (e.g., Intentionally Defective Grantor Trusts), taking back promissory notes that will be repaid over time.  Future appreciation of the assets will inure to the children/borrowers while the repayment installments will provide a stream of income to the parents/lenders.  These strategies depend upon the assets earning sufficient income to support the repayment installments plus the interest.  Interest must be charged (and paid) to avoid an IRS claim that the loan is nothing more than a disguised gift, subject to gift tax.  The minimum interest rate that will avoid such an IRS claim depends upon the interest rate paid by the government on mid-term federal notes.  Obviously, the lower the interest rate, the easier for this strategy to succeed.  Taxpayers should therefore consider implementing such loan strategies now, before interest rates rise.

After Interest Rates Rise:

Strategies that provide a stream of annuity payments to a grantor will benefit most from a rising interest rate environment.  The two most common strategies are Grantor Retained Annuity Trusts (“GRAT”s) and Charitable Remainder Trusts (“CRT”s).

In a GRAT an asset that is expected to appreciate significantly is contributed to a trust for a term of (at least two) years. The grantor receives a stream of annuity payments for the term.  The annuity payments equal the value of the asset contributed to the GRAT plus a market based interest rate.  At the end of the term the asset (which has presumably appreciated) plus any income retained in the GRAT (i.e., income earned in excess of the annuity payments) go to the beneficiaries/heirs tax free.  Obviously, the higher the interest rate, the higher the annuity payments to the grantor and the lower the initial value of the asset contributed to the GRAT may be.

A CRT is a trust that is exempt from tax on income that it earns because it provides for a final remainder distribution to charity.  The grantor contributes an asset to the CRT (usually a highly appreciated asset) which the CRT may sell free of tax.  During the term of the CRT (which may be up to twenty years or for the lifetime of the grantor and/or his/her family members) the trust must make annual distributions to the term beneficiary (usually the grantor and/or his/her family members).  The idea is to structure the size of those distributions so that over the term of the CRT, 90% of the initial asset contribution plus its assumed appreciation is distributed to the term beneficiary and 10% of the initial contribution (the remainder) is left for charity.  The higher the prevailing interest rate is at the creation of the CRT, the higher the annual distributions will be to the term beneficiary.

Various combinations and permutations of the above strategies (GRATs, GRUTs, CRATs, CRUTs, SCINs, etc.) are available in order to maximize their effectiveness depending upon a particular taxpayer’s situation.  The above descriptions have been significantly simplified to provide general information about the strategies that are available. These strategies should be discussed and implemented with qualified tax counsel.



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