Effective Estate Tax Planning from Schmeg.com

   

THE "GIVE IT TWICE" TRUST
Tis better to Give And Receive

You can't take it with you, but you can give it away twice.
The perfect plan for giving is to give it away twice, once to family and again to charity using appropriate trusts. If you don't use a proper trust, taxes can take a large bite out of your funds. Using the leverage of deferring taxes and compound growth on the larger sum, the family gets more, not less, and the gift to charity at the end is a bonus without "costing" heirs anything. Leaving wealth outright to family is helpful in some cases, but can be destructive in others; however, leaving a gift to charity always makes a difference in the long run. Gifts on death to family members are often spent on things with little or no lasting value, except education. Warren Buffett said, "The perfect inheritance is enough money so the heirs feel they could do anything, but not so much that they could do nothing." Andrew Carnegie said, "The parent who leaves his son enormous wealth generally deadens the talents and energies of the son and tempts him to lead a less useful and less worthy life than he otherwise would."

There are many ways to give to your University, Church, Synagogue or favorite charity, and the tax consequences are varied depending on the individual's circumstances and the method of giving. There are usually minimum trust sizes of at least $250,000 and significant set up costs involved, except for gifts via a Family Trust from an IRA or 401k where the minimum size is only $60,000 and set up costs are minimal. a Family Trust allows the children (heirs) to benefit (inherit) from your IRA or 401k by getting a 7% payout for 20 years (= 140% less income tax = 100%) and 100% is left for charity, rather than paying 41% in income taxes off the top and leaving the children only 59%. If the gift is ultimately to a Donor Directed Fund, the children can end up directing the Trustee to give to charities of their choice, bringing the children into responsible social decisions. Gifts to charity are used for the good work the charity does or is reserved in an endowment fund to keep the charity funded permanently.

For those with taxable estates, (currently $1,500,000 or more) charitable gifts of appreciated assets, either during life or on death, result in significant tax avoidance, on both the capital gains (18% to 25%) or the estate tax (45% to 48%), and in the case of IRAs or 401ks, avoidance of both estate tax and ordinary income tax (up to 85%).

The concept of "good assets" and "bad assets" from a tax perspective are that good assets have no income tax, estate tax or no capital gains tax liabilities. Bad assets have some or all of those tax liabilities. For example, IRAs are bad assets because they always have at least income tax liability and possibly estate tax liability; real estate can be a bad asset if it eats up capital gains step up exemption in addition to estate tax; on the other hand, cash or cash equivalent investments are always good assets because they are only subject to estate tax when the estate is large enough. When a person considers making a charitable gift, it is always best to give "bad assets" first so the tax liabilities disappear. If the gift is given to charity, the charity doesn't have to pay the tax.

When planning a charitable gift, you should always try to "give it away twice," once in the form of reserved income to family members and second in the form of a gift to charity.

Various ways to make charitable gifts:

Current Giving - The Static Pie Concept. Gifts made, usually during life, with little thought to tax consequences other than the charitable gift deduction for gifts to charity. When its given away its gone, reducing the amount left, such as:

1. Outright gifts without restriction. These gifts can be made during life or in your Will or Living Trust. These should always be from "bad assets" such as appreciated stock or real estate. The recipient has to worry about the tax consequences because the recipient gets your basis in the gift. Of course a gift of "bad assets" to a non-tax paying charity is nothing to worry about.

2. Gifts of Appreciated Property. If you own stock or real estate that has a present market value in excess of your cost or basis in the asset, you can use the market value as the tax deductible value of the gift (not your cost) if you give it to a charity. That results in the appreciation escaping capital gains tax and you getting an ordinary income tax deduction for the full value. Gifts of appreciated property are limited to 30% of your Adjusted Gross Income in the year of the gift with a carry forward as necessary for up to five additional years. On the other hand, gifts of non-appreciated assets or cash is limited to 50% of AGI with a five-year carry forward.

Planned Giving - The Tax Exempt Compound Growth Replacement Concept. Gifts to charity that also provide a financial benefit to the donor or donor's estate (income, tax deductions, limited liability) are called "planned gifts." Planned Giving is the expression of personal values through the integration of philanthropic, family and financial goals. Some of the forms of planned gifts are as follows:

1. Gifts of IRAs or 401ks - If you have an IRA or 401k, all or part of which you do not need, and the resulting addition to your estate will cause additional estate tax and income tax, the tax bite can exceed 80%, making these assets primary gifting targets. Currently (2003) these assets cannot be given away during life without recognizing the income and taking the tax deduction (a wash), however, a bill is ready for introduction in the next Congress to allow fully deductible gifts of IRAs and 401ks during life without first recognizing the income. a Family Trust as beneficiary of an IRA on the death of the IRA owner for an amount as small as $60,000 remaining at death, prevents the imposition of income taxes (up to 35% Federal plus 6% GA) on the death of the surviving spouse. It also effectively lets the IRA owner give it away twice over a 20 year period after the surviving spouse's death at 7% per year-- without losing 41% off the top in taxes; and its cost of set up and administration is minimal. The children net more than 100% of the principal amount over time (grossing over 140%) and can't blow it on one ill-advised expenditure or investment. Also, a Family Trust for the IRA of the first spouse to die can protect the children of a prior marriage to insure their inheritance. It can provide the same income to a surviving spouse as a rollover IRA, but with more flexible payout options and less tax. In any case, its cost is minimal compared to the 41% tax bite otherwise imposed.

2. Gifts of Life Insurance - If you no longer need the life insurance, consider gifting it to your University, Church, Synagogue or favorite charity.

3. Gifts of Charitable Remainder Unitrusts - The Charitable Remainder Unitrust is a special trust that pays income (at least 5% per year) to family members. After all income payments have been completed, the remainder is distributed to charity. The major benefits of the trust are bypass of capital gains tax, increased income and a charitable income tax deduction. A Family and Community Trust is such a trust, structured to be the beneficiary of an IRA or 401k.

4. Gifts of Charitable Gift Annuities - A Charitable Gift Annuity is a combination of a gift to charity and an annuity. For senior persons, annuity payout rates may be 8% or higher. Since part of the annuity payment is tax-free return of principal, the gift annuity may provide the annuitants (persons receiving annuity payments) with substantial income for life. The income stream is paid for one or two lives at a fixed dollar amount, and the principal goes to the charity at the end of the last life. The deductible value of the gift is the present value of the future remainder gift to the charity.

5. Gifts of Remainders following reserved Life Estates - If a person owns a home or a farm and intends to continue to live in the property for life, he or she can still receive a substantial income tax saving. This tax saving is accomplished through a life estate reserved agreement. The donor simply retains use of the home or farm for life, and deeds the remainder interest in the property to a charity so that the charity will own the property after the owner passes away. The deductible value of the gift is the present value of the future remainder gift to the charity.

6. Gifts of a Lead Trust - Property may be transferred to family members at very low tax rates by permitting income to go first to charity for a selected period of years and then distributing the principal to family members. There is a gift tax charitable deduction for the current value of the income that will be distributed to charity. The difference between fair market value and the gift deduction is the actual taxable gift to family members. Many persons have used these trusts to pass on very valuable properties to children and to grandchildren. The children or grandchildren will receive an extremely valuable asset and in most cases will have no transfer taxes to pay upon receiving the property.