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HOW TO EFFECTIVELY REDUCE
FEDERAL AND STATE DEATH TAXES
Both federal and state taxes can be imposed on the transfer of
property in an estate planning context. These include:
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Federal Estate Tax
on property transferred at death,
if the total value transferred exceeds the exemption amount in effect in the
year of death. |
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Federal Gift Tax
on property gifted during
life, if the total of all lifetime taxable gifts exceeds the allowable lifetime
exemption. There is also an annual exclusion, currently in the amount of
$13,000 per donee, for gifts of present interests in property. |
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Federal Generation-skipping transfer (GST) tax
imposed on transfers from grandparents to grandchildren or more remote
descendants, if the total amount of such transfers exceeds the applicable
exemption amount. |
 | Pennsylvania Inheritance Tax
imposed both on property
transferred at death (with no exemption amount) and property
gifted within one year of death if the total of such gifts per donee
exceeds a set exemption amount. This state tax is imposed separately from
the federal estate tax. |
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Other
State Estate Taxes |
If you are domiciled in another
state or own realty or tangible personal property in other
states, death taxes may also be due to those states.
Double Taxation on Retirement
Benefits
and Other Income Tax-Deferred
Assets
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Assets that consist wholly or partially of
tax-deferred income are subject to two types of taxes when they pass to
beneficiaries on account of death. |
Examples of such tax-deferred assets are
qualified retirement accounts, annuities, and certain United State Savings
Bonds.
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First, there will be federal and possibly
state death taxes imposed on the date-of-death value of those assets.
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In addition, federal income tax will be
payable by the beneficiaries on the amount of tax-deferred income they
receive from the inherited asset in any calendar year.
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What Property Is Subject to Death Taxes?
The definition of the "gross estate" for transfer tax purposes is much broader
than the definition of the probate estate. It includes all
property over which the decedent exercised ownership or control, and property
the title to which the decedent may have transferred during life but still retained the use and enjoyment of
it until death.
What Is the Current Law on
Federal Estate Taxes?
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Rules for 2012 |
The exemption amount is $5 million for decedents dying in 2012, with the
highest estate tax rate set at 35%.
However, under current law the exemption amount is due to be reduced as of January 1, 2013
to only $1 million, and the highest estate tax rate increased to 55%.
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A Long-Term Solution?
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If the federal tax legislation passed in
December 2010 is any indication, we will not know until very late in 2012
what the estate tax rules will be for 2013 and beyond. Will the exemption
amount stay at $5 million, or will it be reduced to $3.5 million or even
as low as $1 million?
Regardless of the exemption amount chosen,
will it be another temporary fix lasting only a few years, or will it
finally be made permanent?
LIFETIME GIFTS
AND OTHER TRANSFERS
 | Death taxes are most effectively avoided by
LIFETIME planning techniques. Some common
lifetime techniques include: |
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Gifts made within the federal gift tax annual exclusion limit, which
for 2012 is $13,000 per donee per calendar year. (The annual exclusion
amount may increase in future years based on inflation.)
● Irrevocable life insurance trust to hold ownership of life insurance.
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Charitable remainder trust
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Allows
tax-advantaged sale of highly appreciated assets
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Guarantees
income to the grantor(s) for life or a set term of years
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Charitable lead trust
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Reduces the taxable value of assets ultimately
intended for family members
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Valuation Discount Entities for Closely Held
Business Interests - Can result in
reducing the valuation
of such assets for transfer tax purposes. Form of the entity can be: |
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Family Limited Partnership
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Limited Liability Company
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S Corporation
Death -Time Tax-Savings Techniques
Marital Deduction Planning
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An essential issue to consider when
planning for married couples is to decide whether their assets are
now (or are likely to become) large enough to suggest that they go
beyond the simple "all to my spouse" type of estate plan, and engage in
more sophisticated marital deduction planning. |
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Subject to the portability rules discussed blow, for married clients
with combined assets in excess of the federal estate tax exemption
amount, good planning should
involve the utilization of the unified credit in the estate
of the first spouse to die. |
This technique will entail placing assets in a special "credit
shelter" trust for the surviving spouse's lifetime. The trust can benefit
him or her, but will not be taxable at the surviving spouse's death.
 | Planning becomes a challenge in the
present climate of uncertainty over what the amount of the federal estate
tax exemption will be in 2013 and beyond, and whether the concept of
portability (discussed below) will remain in the law after 2012. |
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One solution is to use the "Disclaimer
Trust"
approach for allowing the surviving spouse's "credit shelter" trust
to be created and funded after the first spouse's death. This technique affords
maximum flexibility in choosing how much, if any, of the assets should be placed
into trust for the surviving spouse. |
Portability of First Spouse's
Unused Exemption Amount
 | The Tax Reform Act of 2010 provides
temporary relief for married taxpayers in the ability of both spouses’
exemption amounts to be fully utilized. The surviving spouse’s estate can now use both
his or her own exemption amount, plus any exemption amount that was not used
by the
first spouse’s estate. |
 | This "portability" rule eliminates the need for
spouses to unwind jointly owned property as part of the estate planning
process in an attempt to ensure that each will own assets equal to the
exemption amount (since the order of deaths cannot be known). Now
they can continue to own their property jointly if they wish. |
Caveat.
One important caveat to this portability concept is that the surviving
spouse’s estate’s use of the first spouse’s unused exemption amount will not
be automatic. The executor of the first spouse’s estate must file
a Federal Estate Tax Return in which the unused exemption amount is computed and an
election is made allowing such amount to be used by the surviving spouse’s
estate. In addition, the return must be timely filed (usually nine months
after the death of the first spouse.)
Thus, planning for the use of the unused
exemption amount must be done at the first spouse’s death. If not done then,
it will be too late to claim the unused exemption amount at the surviving
spouse’s death.
 | This portability provision is due to
expire at the end of 2012. However, portability may prove to be so popular a
concept that it will be continued in the law regardless of what other
changes may occur as of 2013. |
Charitable Remainder and Lead Trusts
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Same rules as with lifetime charitable
trusts. |
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