The basics of estate planning

What’s the federal estate tax? How about the estate tax for your state? How can I give tax-free? Keep the following column handy for helpful answers to common starting points.

It happens about two times a week or at least than 100 times a year. A reader of this column calls me with an estate-planning question, but has no clue about the basics of the subject. So, what follows is a keeper. Put this article in a safe place, so you can refer to it when needed.

The federal estate tax

For 2016, every person is entitled to what is called a “unified credit” (we call it a “freebie”) of $5.45 million. So, if you are single and worth $5.45 million (or less) on the day you go to heaven, you escape the clutches of the estate tax monster.

What if you are married? Double it. The first $10.9 million (for 2016) of your wealth is free from an estate tax.

Now, the freebie is indexed to inflation. So, the tax-free amount is likely to increase every year. What if you want to know the amount of the freebie a year (or more) down the road? Just go to Google and type in, “Federal estate tax rate.”

Every dollar in excess of the freebie is taxed at the rate of 40 percent.

State estate tax

Sorry, as of today, 20 states have an estate tax. This area is in a constant state of flux. When you want to know the estate tax damage for your state, again go to Google, and type in “Estate tax (your state).”

You can get nailed for state estate tax on much smaller estates than for federal estate tax, and most states have a top tax rate of 16 percent. Dangerous. Get professional help.

Basics of gifts

Lifetime gifts to your younger family members represent a major tax-planning strategy. Gifts are an easy way to move assets and the income produced by those assets within the family unit. Best of all, gifts remove assets from your estate. 

Gifts can help divide family income by taking advantage of the zero or low tax bracket of one or more family members. This gift strategy accomplishes two sure tax savings: 1) income — transfers income (produced by the asset gifted) from the donor’s (Joe in the example that follows) high bracket to the low bracket of his children and/or grandchildren, and 2) estate tax — the asset is removed from the donor’s estate.

In the discussion that follows, all gifts are made by Joe, and/or Mary (Joe’s wife) to their children or grandchildren.

Gifts can be free of any gift tax on a year-to-year basis. Each year stands alone. For example, Joe can give $14,000 (called the “annual exclusion") to each of his four kids and six grandchildren (a total of $140,000) in 2016 – all tax-free. He can repeat the same gifts every year tax-free. The person receiving the gift is called a “donee.”

Mary can do the same tax-free gifts as Joe or a total of $280,000 per year. If only Joe makes the $280,000 in gifts to his same 10 heirs of $28,000 each, Joe and Mary can split the gifts (Joe is considered to have made 10 $14,000 gifts and the same for Mary). So, Joe’s $28,000 gift to each donee is still tax-free.

How much can you give tax-free?

Suppose Joe makes a gift of $2 million to each of his 10 heirs ($20 million total). So, under the tax law, the gift is split: Joe made a $10 million gift, so did Mary.
Note: The gift tax and the estate tax share the same rate schedule and the same unified credit. Remember, the top rates are the same for both — 40 percent.
Computing the gift tax Joe must pay is easy. As explained above, the annual exclusions for Joe’s gifts are $140,000. Joe’s unified credit of $5.45 million escapes the gift tax. So subtract the $140,000 and the $5.45 million from Joe’s $10 million gift. You get $4.41 million that is a taxable gift.

At 40 percent, Joe must pay the gift tax monster $1.764 million, and so must Mary.

Would Joe really make that $20 million gift? Maybe. He will save 40 percent of that $1.764 million (or $705,600) in estate taxes. And so will Mary. Not too bad!
Gifts are indexed to inflation. Someday, when inflation rises enough, each donee will be able to receive a $15,000 annual exclusion per year gift-tax free.

The classic leveraged gift

Want to win the estate tax game? Again, think gifts. Leveraged gifts. Joe would like to enrich his grandchildren. So, Joe and Mary make a gift of $12,709 each year to each of the six grandchildren via an irrevocable life insurance trust to pay an annual premium for six separate $1 million second-to-die policies for a 15-year period (then the policies will self-carry) What’s the result? $76,254 ($12,709 times 6) is removed from their combined estate each year. After Joe and Mary are gone, the grandchildren will have $6 million ($1 million each) tax-free at a maximum cost of $1,143,810 ($76,254 times 15).

How much do you think Joe must earn to leave his grandchildren $6 million? Would you believe about $16.66 million? Try this: Joe earns $16.66 million more before going to heaven. After paying the IRS 40 percent ($6.66 million) for income taxes, he has $10 million left. When he dies, the IRS gets another 40 percent of the $10 million. What’s left? $6 million.

Or put another way: An investment of $1,143,810 in insurance premiums (less if Joe and Mary both die before 15 years) will do the same work as earning about $16.6 million.

Shhh! Don’t tell the IRS.

As always, if you have a question you are welcome to call me (Irv) at 847-674-5295 or email me (

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