Within the last year a concept has developed whereby families whose net worth exceeds $1,400,000 in this calendar year (the approximate amount of assets that can be transferred free of federal estate tax by using two exemption equivalent credits of $675,000 each, plus adjustment for the state death tax credit) can reduce their federal estate taxes to zero. The first time you hear this, your natural reaction is “you must be kidding.”
Upon investigation we find that it is possible to reduce federal estate taxes upon the death of the second spouse to die to approximately zero. This can be accomplished only by a family with strong charitable interests. Through the use of carefully planned giving, the family is able to give assets to the charity instead of the Internal Revenue Service.
Here is an overview of how this plan works with a family oriented toward making substantial charitable contributions presently and in the future:
The family establishes a nonprofit corporation organized as a private charitable foundation and obtains tax exempt status for the foundation from the IRS.
The foundation is administered by the members of the family and in the future by their children. No unaffiliated trustee or director is required.
The foundation may make gifts only to other tax exempt organizations such as a hospital, university, United Way, church, or another qualified organization.
The surviving spouse’s estate contributes all assets owned (a sizable amount of which may be the remaining assets in a qualified pension or profit-sharing plan or in a roll over IRA) to the foundation for a term of years, such as 20 years. At the end of the term the remaining assets pass to the children and grandchildren. This entitles the estate of the second spouse to die to a charitable deduction. Depending upon the type of charitable gift by the estate of the surviving spouse, the charitable deduction is planned to be equal to the taxable estate minus the amount of the exemption equivalent credit. This eliminates all estate taxes upon the death of the second spouse to die. (Presumably, there were no estate taxes when the first spouse died because of the estate tax marital deduction.)
Up to this point the plan virtually eliminates the children and grandchildren as heirs to the surviving spouse’s estate. Accordingly, the second major ingredient is to provide for those heirs in another plan which is free of estate taxes. To do this the family establishes an irrevocable trust and the trust purchases “second-to-die life insurance” on the lives of the parents. Alternatively, the children can purchase second-to-die life insurance. In either event, upon the death of the second spouse to die the proceeds of this life insurance is not includible in that spouse’s estate for federal estate tax purposes.
Although often denied, life insurance does have a cost. Premiums for second-to-die life insurance can be modest or substantial, depending on age and health, and generally can be funded with tax-free gifts.
In a simplified example, if the combined gross estate of a married couple is $10,000,000 and upon the second death a gift of $9,000,000 is made to the foundation, approximately $5,000,000 in death taxes will be saved. Second-to-die life insurance payable to the children is purchased in the amount of $4,000,000 to replace the $4,000,000 that the children didn’t receive.
There are many variations on this concept. Further consideration is warranted if the gross estate is significant, there exists a strong charitable interest, and the parties are insurable.
– Mike Beausang