Estate Tax Planning

Estate tax planning involves structuring the estate plan in order to maximize the tax benefits allowed by the tax law. There are various special trusts and entities under the tax law that help accomplish the transition of substantial wealth. Used in conjunction with life insurance, these techniques not only prevent substantial erosion of wealth due to estate taxation, but can also provide substantial asset protection for one’s family and for generations to come. This may involve one technique or several techniques integrated together. No one technique will apply to all situations and therefore planning and analysis must take into account asset values, family dynamics and class of assets involved (e.g., is there a family business).

Estate Tax Table

Calendar Year

Exemption Amount for Transfers at Death Only

Highest Estate and Gift Tax Rate

2011 $5.0 million 35%
2012 $5.0 million 35%
2013 and after $1.0 million 55%

For the year 2013 and thereafter, the exemption drops back down to $1,000,000 and the top tax rate goes back to 55%, although there is speculation that the exemption amount would revert to the 2009 amount of $3,500,000. In today’s environment, there is really no way to predict how Congress is likely to act relative to tax rates and exemption amounts.


:  Massachusetts has an estate tax on all assets above $1,000,000.  Tax rates range from 9.9% to approximately 16%.

Planning Techniques

Following are some of the more commonly used techniques.

Crummey Trusts

“Crummey Trusts,” offer those who wish to start a gifting program for their children or grandchildren significant advantages over other traditional gifting tools such as UTMA/UGMA accounts and minor’s trusts. The advantages of the Crummey trust fall into the categories of asset protection and control over trust distributions. Depending on state law, a demand trust provides beneficiaries with asset protection for the duration of the trust. This requires careful drafting to navigate various state laws as well as complex income and estate tax rules.

With a Crummey trust, there is no requirement, as with UGMA/UTMA accounts and minor’s trusts, that beneficiaries receive the trust assets outright upon turning eighteen or twenty-one years of age. In fact, if desired by the grantor, the beneficiaries of the Crummey trust could never get complete control over the trust assets. In the Crummey trust, payment by the trustee of income or principal can be made discretionary, as long as the trustee is not also a beneficiary (an “Independent” Trustee).

Because the beneficiary does not have a right to the trust assets, except during the brief demand period, the trust assets are normally untouchable by creditors, including ex-spouses, as long as the assets are held in the trust. A Crummey trust, because of its flexibility, gives parents and grandparents greater control over their gifts than outright gifts — whether to minor children/grandchildren (UGMA/UTMA accounts) or adult children and grandchildren.

Donors, through powers vested in the trustee or instructions within the trust, can control the timing of distributions to combat fears of the donee’s immaturity, inexperience, or lack of respect towards money. Any concern that a substantial gift can “de-motivate” an heir can also be addressed through proper instructions drafted into the trust agreement. The document can include instructions for specific uses of trust assets (for example, a college education) for the beneficiary.

When a grandparent wants the minor’s parents to be the trustees, the trust must be drafted very carefully in order to keep these gifts to grandchildren out of the parents’ estates.

Dynasty Trusts

A “Dynasty Trust” is an irrevocable trust (and can also be a Crummey trust) that is designed to continue for the lives of children, grandchildren and even great-grandchildren. Because transfers to successor generations are subject to the “generation skipping transfer tax”, special care must be taken in drafting to avoid, or minimize the tax. Each taxpayer has a GST exemption that can be placed in a trust that will continue on for generations with no estate taxes imposed after the parents have died. When this tax is successfully avoided, then assets can accumulate for generations completely outside the estate and gift tax systems, thereby preserving family wealth for future generations.

Grantor Retained Annuity Trust — Also known as a GRAT

Planning for large, taxable family wealth is typically complicated by the fact that most often these clients have already made family gifts and have little or no exclusions and applicable exemption amounts left. There is an annual $13,000 exclusion amount per donee and a $5,000,000 total lifetime exclusion. The $5 million lifetime exclusion is scheduled to expire and be replaced by a $1 million exclusion on January 1, 2013. The GRAT is a “leveraged” gifting technique, but is not a “freezing” techniques.

The GRAT is an irrevocable trust in which the grantor of the trust (typically the “parent”) retains the right to a fixed payment for a specified term (an annuity). At the end of the annuity term, any remaining assets in the GRAT (the remainder interest) are paid either outright to children and heirs or paid to one or more irrevocable trusts for the benefit of the grantor’s children and heirs. In the event the grantor dies during the term that the GRAT is in existence, the fair market value of the remaining trust assets will be included in the grantor’s estate. However, this result is no worse than if the grantor did not engage in any GRAT planning at all, and can be hedged effectively by the use of life insurance to cover the GRAT annuity period.

With proper planning and structuring, the GRAT can transfer substantial value to children and future generations with low (or no) immediate gift tax consequences. This is accomplished because the tax law treats the grantor as having made a completed gift at the time the GRAT is established. This gift is equal to the value of the property transferred less the value of the retained annuity interest. The value of the grantor’s retained annuity interest is a function of the number of annual annuity payments retained by the grantor, the desired amount of the retained annuity, and the interest rate that is published monthly by the IRS for the month the GRAT is established. As long as the actual rate of return achieved on the GRAT assets outperforms the IRS mandated interest rate, then assets will transfer to children and future generations free of any current or future transfer taxes. Thus, the lower the IRS mandated rate, the more attractive GRATs are as an estate planning technique.

When the grantor has used most or all of his or her lifetime gift tax exclusion, it is critical that the calculated gift comes as close to zero as possible such that there is no current gift tax liability. This is referred to as the “Zeroed Out GRAT” or the “Walton GRAT”.

The zeroed-out GRAT will allow the grantor to transfer significant amounts of property out of his/her estate with minimal or no taxable gift. If the grantor survives the term of the trust, but dies while the estate tax is in effect, the GRAT can significantly reduce any tax that might be owed. If the estate tax is ever repealed (again), there are no lost dollars, because the transfer did not result in the payment of any tax.

The nature of the asset transferred into the GRAT is an important component of this type of planning. For example, cash transferred into a GRAT will not yield as good a result as an asset with a low initial value but which is anticipated to appreciate at a rate substantially above the initial IRS rate. Assets to plan with would include closely held stock which the grantor anticipates may be sold at a substantial premium (like “IPO stock”). Another very good asset is an interest in a family limited partnership (“FLP”) or limited liability company (“LLC”), since they can be used to obtain valuation discounts thereby increasing the effective rate of return on the GRAT assets. Accordingly, the GRATis often used to transfer closely held stock, rental real estate, and even some marketable securities. It works particularly well with S corporation stock. This is an area where an estate planning attorney well versed in the “mathematics of estate planning” should be consulted.

If limited partnership interests or other discounted assets are used, there is always the possibility that the IRS will try to revalue the assets. A GRAT can minimize this risk of revaluation when the annuity is expressed as a percentage of the initial trust assets. Should the assets be revalued, the annuity payment will either increase or decrease as the case may be, but no additional gift tax (or a minimal amount of gift tax) will be owed.

At the termination of the GRAT interest, the recipient of the net GRAT assets is an important consideration. For example, if the recipient of the GRAT were an irrevocable trust which owned life insurance on the grantor’s life (the “ILIT”), then the assets passing into the ILIT could be used to fund future insurance premiums without having to look to the grantor for future contributions to the trust. In very large taxable estates, once the grantor’s cumulative insurance premiums have exceeded $1 million, substantial complexity is injected into the scenario, since all future premiums are now subject to the gift tax. This issue is avoided, since the assets being received from the GRAT are now being received cleansed of all exposure to estate or gift taxes.

Charitable Trusts

Individuals who have highly appreciated assets, who want to secure a lifetime income, who want to save taxes and benefit a charity, but who want to leave the total value of their estate to their children and grandchildren, should consider the Charitable Remainder Trust (CRT).

One of the more important benefits of a CRT is the income tax deduction realized upon contributing assets to a CRT. While this is common for all charitable contributions, a charitable gift of a remainder interest in property through a CRT generates an income tax deduction where an outright gift of a remainder interest generally would not. The calculation of the value of the remainder interest is set forth in detailed treasury regulations and accordingly, an estate planning specialist in this area should always be consulted. The importance of this benefit is that you can receive a lifetime income stream in the form of unitrust or annuity payments.

Perhaps the most favorable benefit of the CRT is the ability to sell highly appreciated assets without the imposition of capital gains tax. When an individual has a highly appreciated asset that he/she wants to sell, the effect of capital gains tax on the sale often dictates whether or not the sale is made. If the property is contributed to a CRT before the sale, not only does the client get an income tax deduction, but also when the CRT sells the property, no capital gains tax is imposed. As a result, you can convert a highly appreciated low-income or non-income producing asset into an income stream through the CRT without incurring capital gains tax.

Planning with a CRT allows you to realize an income tax deduction, reduce your taxable estate, and receive an income stream for life. Additionally, a CRT may benefit you in the areas of asset diversification and retirement planning. These financial benefits, as a whole, are generally not available if the gift is made outright to charity.