Current Estate Planning Techniques

August 2006

Connecticut, like other states, has its own unique laws regarding Wills, passage of property by intestacy, and death taxes. Your estate plan should be updated as soon as possible after you move to a new state, have a significant change of assets, encounter a family change (marriage, birth of a child, death of a spouse), or are affected by a change of federal or state tax law. Also, as a rule of thumb, a general review every 3-5 years is advisable. Apart from the obvious advantages of permitting distribution of assets in accordance with personal wishes (rather than by state laws of intestacy), and the appointment of an executor or executrix without a bond (a significant expense otherwise required by statute), proper estate planning documentation can incorporate one or more of the following tax-saving techniques:

1.         Wills with Unified Credit Shelter Trusts -- This technique permits a husband and wife to avoid wasting up to $2,000,000 apiece of tax-free asset transfer capability, translating to about $1,000,000 of needless federal estate taxes. (Under 2001 Federal tax reform legislation, the tax-free asset transfer amount will increase to $3,500,000 per individual in 2009 and the potential savings from this technique will accordingly increase to about $1,750,000.) Proper drafting is critical to achievement of this tax savings and the IRS is not very forgiving if essential provisions are altered or omitted.

2.         Revocable (Living) Trusts -- This technique permits probate proceedings to be limited to dealing with just a few assets or, in some cases, eliminated. (Other assets are already in the Trust and pass under its terms.) No tax savings are involved, but savings in probate costs can be realized and delays in passage of title minimized. In addition, family privacy is much more protected than with a lengthy, publicly-probated Will. This is also an excellent means of providing for a possible disability (with a contingent, personally selected trustee) while maintaining total control (with the client as his or her own trustee as long as legally capable).

3.         Gifts to Irrevocable Family Trusts -- This technique uses a client's existing "Unified Credit" (under current law, allowing tax-free transfers of up to $2,000,000) to (a) protect all future appreciation of transferred property from federal and state death taxes, and (b) assure use of the credit before possible Congressional action (as discussed in past years) which may occur in the future to reduce or eliminate the Unified Credit.

4.         Annual Gifts -- This technique combines trust arrangements with the annual gift tax exclusion amount of $12,000 per person to maximize annual transfers of assets on a tax-free basis. If there are multiple children and grandchildren, this technique can move many tens of thousands of dollars annually and without triggering reporting requirements.

5.         Generation Skipping Tax Exemption Trusts -- For clients with family assets in excess of $1 million, this technique permits use of a $l million exemption (adjusted annually for inflation) from the federal Generation Skipping Tax. The 55% GST tax applies to transfers in trust to grandchildren or other "skip" generations. Early use of the credit (particularly with highly appreciating assets) permits a significant "leveraging" to protect much more than $1 million of family assets.

6.         Family Limited Partnerships or LLC's -- This technique permits family businesses or other commercial assets to be passed to future generations at discounted gift values while retaining effective control. In some cases, the value of the business can he "frozen" to allow future appreciation to accrue to the next generation without tax.

7.         Qualified Personal Residence Trusts (QPRT) -- This technique allows a family residence to be transferred to children following a reserved period of exclusive use (usually 5 to 20 years) at a very favorable discounted gift value, resulting in significant tax savings to the family and preservation of the house as a family asset. The donor must survive the reserved term for this to work. However, if the client does not survive, the Unified Credit used at the time the gift is reported is restored.

8.         Irrevocable Insurance Trusts -- This technique permits life insurance on one life or joint lives to be held in trust rather than owned outright, and to have such insurance proceeds excluded from estate taxation. This can be extremely useful in planning for payment of significant projected estate taxes on an estate which would have difficulty producing liquid assets for death tax payments due 6 - 9 months after death (such as estates with significant family business assets, real property holdings, etc.)

9.         Qualified Domestic Trusts -- This technique is a critical planning device for use by spouses where one or both spouses are non-citizens. Failure to use proper "QDOT" trust can make the marital deduction unavailable, causing a burdensome death tax to be due at the death of the first spouse (when taxes are normally deferred under federal "marital exclusion" rules applying to U.S. citizens).

10.       Charitable Remainder Unitrusts -- This technique permits significant gifts to a favored charity to be made in trust while reserving a life interest in the donated property. An income tax deduction is also created. With use of insurance, the family asset can be replaced at death, and premiums can be offset by income tax savings. This is an excellent device for estate planning with highly appreciated, low-basis assets. Charitable lead trusts --giving away the right to income but reserving the property for ultimate distribution to family members -- may also be useful in some plans.

11.       GRATs and GRUTs -- These techniques permit property to be given away in trust with a retained "annuity" or "unitrust" interest reserved to the donor for a period of years which, under IRS tables, substantially reduces the value of the gift for gift tax purposes. The IRS tables can be used to calculate a "zero-out" GRAT based on a purely mathematical actuarial determination that the trust will exhaust itself at the end of the selected term by making the required payments to the donor. If funded with assets exceeding the current "AFR" federal rate of return (now around 4 - 5%), a Trust can outperform the IRS interest rate assumptions built into IRS tables and allow the annuity to be paid while still achieving estate-tax free growth for the Trust. The result is transfer of property to the next generation without estate tax.

12.       Private Annuities -- This technique permits a younger family member to purchase real estate or other assets of an older family member for an actuarially-determined fixed annual payment in order to (1) keep the property in the family, (2) provide income to the current owner while deferring capital gains taxes, and (3) avoid estate taxes on the value of the property (particularly effective if death should occur prior to life expectancy).

13.       Offshore Trusts -- This technique may reduce state income and death taxes and make assets less visible to and attachable by creditors of U.S. grantors. Also, for non-resident aliens planning to relocate in the U.S., proper planning before U.S. residency can save very substantial amounts of future U.S. estate taxes. The IRS definitions regarding "foreign trusts" and related reporting requirements and penalty provisions have recently changed, and not all offshore trust companies are "trust-worthy". Therefore, professional care, know-how and experience in this planning is more important than ever.

14.       Domicile Planning -- Connecticut death taxes have in recent years been among the most burdensome in the country.. Although this is improving under recent "phase-out" legislation, large Connecticut estates (particularly those with non-family beneficiaries) may still attract a significant "Connecticut Succession Tax". The Connecticut Gift Tax may also impose significant gift tax burdens on effective planning which may not exist in other states. It may be possible to establish legal/tax domicile in another jurisdiction and to avoid substantial state death taxes and/or gift taxes, without giving up all connections with Connecticut. Florida is a popular tax-beneficial alternative. Taking the right steps to establish a new tax domicile will be critical to assure that another state (such as Connecticut) does not assert the power to tax a client's assets.

15.       Retirement Plan and IRA Estate and Tax Planning -- A number of tax elections and planning alternatives should be considered in order to minimize risks of burdensome income taxation to a spouse or other beneficiaries. Large rollover IRA's and 401(k) Plans of corporate executives can be particularly tricky due to "deferred income" tax rules.

16.       Pre-Nuptial Agreements -- This technique can limit the effects of state marital laws and pro-spousal probate laws in order to preserve maximum assets for an individual and his/her family contemplating marriage (usually, but not always, for a second or later marriage). Parents concerned about marriages of their adult children can include conditions in their documents requiring such agreements to be in place before certain principal distributions are made from family trusts.

Other techniques may be useful to select situations. With a marginal federal estate tax of 50% or more, the time and expense of proper planning is easily justified by tax savings which can amount to hundreds of thousands of dollars to a single family. Some say that failure to plan one's estate is tantamount to deciding to leave one's hard-earned assets to the Department of Defense, the IRS or other branches of the U.S. Government. Yet with proper planning, this result can be avoided and substantial family wealth preserved for children and other heirs.

Admitted to practice:

Connecticut (1979) New York (1977) Florida (1980)

Martindale-Hubbell Rating: "AV"

Copyright 2006 Frank E. Sisson III All rights reserved.