Paying Estate Tax May Now Be Voluntary

This is our 3rd installment of the planning opportunities available under the new estate and gift tax laws created under the “Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the Act).” This edition of Client Alert will focus on an effective estate planning technique which literally may make paying estate taxes voluntary and “bullet proof” your assets from a financially ruinous lawsuit.

The Act increased the amount that one can give away or die possessed of from $1M to $5M without being subject to gift or estate tax through December 31, 2012. (The new law sunsets in 2013 and reverts back to the 2001 law so take advantage of these benefits while they last.) Married couples can combine their exemption to $10M. Any unused exemption may be added to and used by the surviving spouse.

A common goal in estate planning is to remove future appreciating assets from the estate, especially when the assets are currently depressed in value, and ultimately transfer the future growth to a future generation of beneficiaries without incurring any immediate gift tax. In this manner, the estate tax to be imposed on the future appreciation won’t be collected for one or more generations, allowing the asset values to increase for the benefit of one’s descendants.

Example: An owner of income producing real estate owns an apartment building that used to be valued at $3M but due to the real estate recession is only worth $2M. The owner would want to gift the apartment building to a trust for her children and grandchildren, and with the increased exemption, pay no gift tax. If the apartment building appreciates to $10M over the remaining life expectancy of the parent, the value of the real estate will not be subject to estate tax at the parent’s demise. This estate freeze has the effect of removing $9M of appreciation from death taxes and passing them to her heirs in a highly tax efficient manner. Based on a 50% estate tax rate, the heirs save over $4M in taxes.

Unfortunately, to achieve this result, the parent must give up all “dominion and control” including any of the cash flow (rental income) produced from the property. If an income stream was needed, the foregoing plan was not a very practical planning tool.

Recent developments in the tax law combined with the significant increase in the gift tax exemption, now provide a unique opportunity to make your estate taxes voluntary, while retaining the ability to enjoy the income stream from the gifted asset. In several recent private and public rulings, the IRS has held that a taxpayer who establishes a trust in a jurisdiction with laws that will not allow the taxpayer’s creditors to reach the trust’s assets will be permitted to be a discretionary beneficiary of the trust , allowed access to the income and corpus on a “discretionary” basis, and the value of the assets held in the trust will not be included in the taxpayer’s estate at death. Although certain states restrict a creditor’s ability to levy against trust assets transferred by the taxpayer, there are numerous uncertainties as to whether the states’ laws (other than those of Nevada and Alaska) comply with these IRS rulings. (It isn’t clear whether a non-resident of Nevada or Alaska may gain the protection of the state’s asset protection trust.)

Planning Pointer: The Offshore Trust: There are certain offshore jurisdictions whose laws do comply with the IRS rulings mentioned above. For example, the Cook Islands is one location where regardless of the state in which you reside, you can set up a trust domiciled in the Cook Islands in which you are a discretionary beneficiary and the trust’s assets will be completely outside the reach of your personal creditors. (Even though the Trust is “offshore” for income tax purposes, the trust is taxed as a U.S. grantor trust and the income is reported on the trustor’s personal tax return.) It is not illegal to have an offshore trust provided you tell the IRS you have it and file the necessary tax forms. The assets, themselves, do not have to be offshore, just titled in the name of the trust. These assets can remain at your favorite bank or brokerage firm, or in the case of real estate or entities holding real estate, these assets can be U.S.-based (provided they are held in the offshore trust).

Variations of this technique can be effectively implemented for non-resident aliens owning U.S. real estate and for those wishing to immigrate into the U.S., eliminating U.S. estate tax for such persons.

If you have an interest in learning if this technique can be implemented by you to achieve the foregoing benefits, please feel free to contact me. I would also be happy to speak with your tax professional.

In the next issue of Client Alert, I will describe a structure that will not only allow you to do an estate freeze and retain the use of the cash flow from the assets, but also supercharge the value of the asset being passed on to the heirs.

For more information about any of the information discussed in this Client Alert, or any other income or estate tax planning or asset protection planning assistance, please contact Jeffrey M. Verdon Law Group, LLP at or (800) 521-0464.

Posted in Client Alert.