It's not often that the sequel is better than the original. Yet, for those who read my article last week, which was about who is liable to pay U.S. estate tax, you're sure to like this sequel better. Why? Because it's possible to minimize that potential U.S. estate tax hit.
You may recall from last week that there are three groups who have to be concerned about U.S. estate taxes: U.S. citizens (no matter where in world you live), U.S. permanent residents (those who live in the United States.), and anyone who owns U.S. situs property (assets located in the United States.)
Today, let's talk about planning ideas for U.S. citizens and permanent residents. Next week, I'll finish off this topic with planning ideas for Canadians with U.S. situs property.
Status of tax
You should be aware that legislation is currently in place in the United States that will repeal the estate tax in the year 2010. The catch, however, is that there's a sunset clause in the legislation that will reintroduce the estate tax in 2011. Now, U.S. Senate Majority Leader Bill First has filed a motion to proceed in early September to vote on a bill that could see the indefinite repeal of the estate tax after 2010.
The Republicans (who generally support the repeal) and Democrats (who generally do not) are currently in negotiations to reach a compromise plan that will likely see the estate tax reduced, but not eliminated.
U.S. citizens and residents
So, the need for planning continues. If you're a U.S. citizen or permanent resident (including green card holders), consider these five key ideas.
Make gifts today. U.S. citizens and permanent residents can make gifts of up to $11,000 (U.S.) -- $22,000 for a married couple -- per donee each year without facing the gift tax. This will help to reduce the size of your estate at your death.
Exemption amount. In 2005, the first $1.5-million of your estate can be passed free of the estate tax because of an exemption. This exemption is scheduled to be $2-million in 2006 through 2008, rising to $3.5-million in 2009. The estate tax is repealed in 2010. The exemption is slated to be just $1-million in 2011 and later years, but is likely to be increased as a result of current U.S. Senate negotiations.
Marital deduction. If you leave your entire estate to your U.S.-citizen spouse, you'll be entitled to a marital deduction that will effectively defer the estate tax until your surviving spouse dies. If your spouse is not a U.S. citizen, there is a $117,000 (in 2005) limit on this tax-deferred rollover to your spouse, so other planning could be required.
Life insurance trust. U.S. citizens and permanent residents who own life insurance policies on their own lives can face estate tax on the proceeds of that life insurance. Consider creating an Irrevocable Life Insurance Trust (ILIT) to own your policies and avoid the tax.
Bypass trust. If you leave everything to your U.S.-citizen spouse, you'll defer estate tax, but you'll fail to use up your $1.5- million (in 2005) exemption amount. If your spouse then dies, he'll have his $1.5-million exemption only. Your exemption will have been wasted.
A bypass trust typically works this way: On your death, assets equal to your exemption amount are placed in an irrevocable trust with your spouse as beneficiary and the kids as beneficiaries of the remaining interest (the assets in the trust after your spouse's death). The amount placed in the trust will be taxable, but sheltered from estate tax using your exemption.
Tim Cestnick, FCA, CPA, CFP, TEP, is a tax specialist and author of Winning the Tax Game 2005 and The Tax Freedom Zone.
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