Life Insurance Trusts
Crummey Trusts for Gifts to Children
Charitable Remainder Trusts
Estate tax marital deduction: Don't 'overqualify'
Limited Liability Companies

Qualified Personal Residence Trusts
A special kind of irrevocable trust can be used to transfer your home to your children at a significantly reduced gift tax cost and with no estate tax, yet allow you to continue to live in the home for as long as
you wish. This special type of trust is known as a qualified personal residence trust (QPRT). Here's how it works.

During your lifetime, you transfer your home to the trustee, who can be yourself. The trustee must allow you to continue to use the home rent-free for a fixed number of years specified in the trust instrument (the "fixed" term), which should be a term you are likely to survive. During the fixed term, you will continue to pay mortgage expenses, real estate taxes, insurance, and expenses for maintenance and repairs, and will continue to deduct mortgage interest and real estate taxes on your individual income tax return. When the fixed term ends, the home is distributed to your children, or remains in further trust for them.

Even after the fixed term ends, you can continue to use the home in one of three ways. First, rather than immediately distributing the home to your children, the home can be retained in trust for your spouse's lifetime, thus assuring that the home is available indirectly to you.

Second, you can repurchase the home from the QPRT before the end of the fixed term. You then will be free to live in the home for as long as you wish, and the proceeds paid to the trustee will go to your children without any additional gift tax and with no estate tax. Alternatively, you can enter into a lease with your children which will allow you to live in the house for as long as you wish.

Although your transfer of the home to the trust is a taxable gift, you are allowed to subtract from the value of the home the deemed rental value for the term you have retained. Generally, no gift tax will be due as a result of your gift to the trust since the gift (after subtracting the rental value of the home for the term you have retained) would be unlikely to exceed your available exemption from the gift and estate tax. (The exemption is $625,000 in 1998, and it will gradually rise to $1 million by 2006.) If you survive the fixed term of the QPRT, the value of the home will not be included in your estate for tax purposes.

Life Insurance Trusts
Few people realize that, even though they may have a modest estate, their families may owe the government hundreds of thousands of dollars because they own a life insurance policy with a substantial death benefit. This is because life insurance proceeds, while not subject to federal income tax, are considered part of your taxable estate and are subject to federal estate tax at rates from 37% to 55%.

The solution to this problem is to create an irrevocable life insurance trust to own the policy and receive the policy proceeds on your death. A properly drafted life insurance trust keeps the insurance proceeds from being taxed in your estate as well as in the estate of your surviving spouse. It also protects the trust beneficiaries from their own "excesses," against their creditors and in the event of divorce.

Moreover, the trust also provides reliable management for the trust assets. Here's how the irrevocable life insurance trust works.

You create an irrevocable life insurance trust to be the owner and beneficiary of one or more life insurance policies on your life. You contribute cash to the trust to be used by the trustee to make premium payments on the life insurance policies. The contributions you make to the trust for premium payments generally will qualify for the annual gift tax exclusion. The life insurance trust typically provides that, during your lifetime, principal and income, in the trustee's discretion, may be paid or applied to or for the benefit of your spouse and descendants. This allows indirect access to the cash surrender value of the life insurance policies owned by the trust, and permits the trust to be terminated if desired despite its being irrevocable. On your death, the trust continues for the benefit of your spouse during his or her lifetime. Your spouse is given certain beneficial interests in the trust, such as entitlement to income, limited invasion rights, and eligibility to receive principal. On the death of your spouse, the trust assets are paid outright to, or held in further trust for the benefit of, your descendants.

Crummey Trusts for Gifts to Children
Everyone can give away up to $10,000 each year to each of an unlimited number of donees, free of gift and generation-skipping transfer tax. Where the donee is a minor, many parents and grandparents make their annual gifts to a custodial account under either the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA). An UGMA or UTMA account works well and is easy to create and maintain. However, it has one major defect: when the child (or grandchild) reaches age 21 the beneficiary can do whatever he or she wants with the money in his or her custodial account. If, for example, the beneficiary wants to buy a sports car instead of going to college, there is nothing that you can do about it.

Charitable Remainder Trusts
There is a very powerful estate planning tool that may enable you to reduce your liability for income and estate taxes and diversify your assets in a tax-advantaged manner. It's called a charitable remainder trust (CRT). Here's how it works.

A CRT is an irrevocable trust that makes annual or more frequent payment to you, typically until you die. What remains in the trust then passes to a qualified charity of your choice. A number of advantages may flow from the CRT.

First, you will obtain a current income tax charitable contribution deduction for the value of the charity's interest in the trust. The deduction is permitted when the trust is created even though the charity has to wait to receive anything.

Second, the CRT is a vehicle that can enhance your investment return. Because the CRT pays no income taxes, the CRT generally can sell an appreciated asset without recognizing any gain. This enables the trustee to reinvest the full amount of the proceeds and thus generate larger payments to you for your life.

The trust will be eligible for the estate tax charitable deduction if it passes to one or more qualified charities at your death. If you wish to replace the value of the contributed property for heirs who might otherwise have received it, you could use some of your cash savings from the charitable income tax deduction to purchase a life insurance policy on your life for their benefit. Often, through the leveraging effect of life insurance, it is possible to pass on assets of greater value than those contributed to the trust. In this way, your heirs are not deprived of property they had expected to inherit.

The Tax Relief Act of 1997 requires that the remainder interest eventually passing to the charity be at least 10% of the amount contributed to the trust, determined by actuarial calculation. In addition, the Act limits the annual payout to 50% of the value of the trust. The effect of these new rules is to curtail the use of CRTs with young life beneficiaries. However, such trusts can still be used by mature taxpayers to avoid capital gains tax on assets with a low income tax basis and reinvest the value in assets producing a higher rate of return.

Estate tax marital deduction: Don't "overqualify"
There are no limits on how much of a marital deduction your estate can qualify for. Thus, if your entire estate goes to your surviving spouse, your estate will owe no federal estate tax. Many taxpayers take this simple approach. In the long run, however, it can cost your family hundreds of thousands of dollars in extra estate taxes. Here's what's involved.

Every individual is entitled to a 'unified' credit entitling him to transfer $625,000 in cash or property free of federal estate or gift taxes ('transfer' taxes). (The $625,000 amount, which applies in 1998, will gradually rise to $1 million by 2006.) Property doesn't have to be transferred to the individual's spouse to qualify for this credit. A husband and wife, therefore, can transfer a total of $1,250,000 ($625,000 each) to their children (or other beneficiaries) in 1998, free of transfer taxes. If the first of them to die leaves everything to the surviving spouse, however, he will have failed to take advantage of his unified credit. At the later death of the spouse, assets with a value of from $625,000 to $1 million (depending on the year of her death) passing to the children will be 'sheltered' by her credit, but the rest of the 'parental' estate will be taxed.

Example (1). Harry dies in 1998 with an estate of $2 million which he leaves in its entirety to his surviving spouse, Wilma. Harry's estate has no estate tax liability due to the marital deduction. Wilma dies in 1999 with the $2 million comprising her estate. After applying her unified credit, the estate tax bill will be roughly $570,000.

Example (2). The facts are the same as above except that Harry leaves only $1,375,000 to Wilma and $625,000 to their children. In this case, Harry's estate will still owe no estate tax due to the combined effect of the marital deduction and unified credit. At Wilma's later death, her estate is $1,375,000, instead of the $2 million in the first example. Now, after applying her unified credit, the estate tax bill will be roughly only $291,000. By having Harry keep $625,000 from qualifying for the marital deduction, roughly $279,000 in estate taxes are avoided.

Property passing to the spouse. One reason an estate may overqualify for the marital deduction is there are ways for property to go the spouse automatically -- that is, not via the taxpayer's will or through his probate estate. Two common examples are jointly owned property and life insurance.

If a married couple owns property jointly with survivorship rights, the surviving spouse obtains complete ownership by operation of law outside the estate. Under the estate tax rules, half the value of the property is included in the gross estate but qualifies for the marital deduction since it goes to the surviving spouse. Similarly, if the surviving spouse is the beneficiary of life insurance which is included in the estate, the marital deduction applies.

Accordingly, to avoid 'overqualifying' for the marital deduction, it is important to know what property is already targeted to go to the surviving spouse. Then steps can be taken within your estate plan to make sure enough assets are set aside to take advantage of the unified credit.

If you are hesitant to remove $625,000 or more of your assets from your spousal bequest for fear of leaving your spouse with insufficient property to meet her needs after your death, special arrangements can be made to achieve your goals. One way is to place assets in trust with your spouse receiving the income interest for life and with your children receiving the assets at the spouse's death. The trust can be set up to avoid qualifying for the marital deduction at your death, thus avoiding inclusion in your surviving spouse's estate at her death.

Limited Liability Companies
There is a new way of doing business that combines the advantages of a partnership and a corporation. It's called a limited liability company (or LLC). You may have heard about it. Here is what it can mean for you.

A business can be conducted in a number of forms, such as a partnership, a regular corporation, or an S corporation. Doing business as a partnership has many tax advantages. Income is taxed only once, and there is great flexibility in how income and deductions are passed through to the partners. But the partners' assets are put at risk, since each general partner is personally liable for the partnership debts and obligations.

Corporations don't have the liability problem, since shareholders aren't responsible for debts of the corporation. However, a corporation's income may be taxed twice, once when the corporation earns it and once when it is distributed to the shareholders in the form of dividends.

Electing to be an S corporation avoids double taxation. But S corporations have many restrictions as to the number and type of shareholders, classes of stock, ownership of subsidiaries, etc.

The limited liability company, which is recognized by almost every state, including California, offers a way out of this dilemma. An LLC is owned by investors known as members. It is managed either by the members themselves or by designated managers.

Like shareholders of a corporation, the members' liability is limited to the amount of their investment. Yet, if the LLC is structured properly, it will be treated as a partnership for tax purposes. And there are no restrictions on the number and type of members, as there are with the shareholders of an S corporation.

If you are already doing business as one of the other entities, it may make sense to convert to an LLC.