These Trusts Can Provide Estate Tax Efficiency

qualified personal residence trust

The estates of high-net-worth individuals can be heavily impacted by estate taxes. We are using the plural because there is a federal estate tax, and there is also a Connecticut state-level estate tax. Fortunately, there are steps that you can take to mitigate damage if your estate is exposed.

Estate Tax Exclusions

There is a federal estate tax exclusion, which is a set dollar amount that can be transferred tax-free. The estate tax would potentially be levied on the portion of an estate that exceeds the exclusion.

It was $5.49 million in 2017, but in December of that year, the Tax Cuts and Jobs Act was enacted. A provision in this measure doubled the exclusion for 2018, and it was indexed for inflation. This resulted in a $10.18 million exclusion.

Since that time, there have been annual inflation adjustments. During the current calendar year, the federal estate tax exclusion sits at $12.07 million, and there is a 40 percent maximum rate.

There is an unlimited marital deduction, so any amount of property can be transferred to a surviving spouse tax-free, but there is a caveat. This deduction is only available to American citizens.

The state-level estate tax exclusion in Connecticut is $9.1 million this year. Next year, it will be raised to equal the federal exclusion, and this will be the arrangement going forward.

Federal Gift Tax

You cannot avoid the estate tax by giving lifetime gifts because there is a gift tax as well. It is unified with the estate tax, so if you give large gifts while you are living, you will be using some of your estate tax exclusion to give the gift tax-free.

However, there is an additional $16,000 per year, per person exemption. The first $16,000 you give to a recipient can be transferred tax-free without using any of your unified exclusion.

Wealth Preservation Trusts

Now that you understand the framework, we can look at a few of the trusts that can be used to mitigate your estate tax burden. As we have stated, you cannot use the marital deduction if you are married to a citizen of another country, but there is a solution.

You can convey resources into a qualified domestic trust (QDOT). If you predecease your spouse, the trustee that you name in the trust declaration will distribute the trust’s earnings to your spouse for the rest of their life.

The estate tax would not be levied on the distributions, but ordinary income taxes would apply. If the trustee distributes a portion of the principal, the distribution would be subject to the estate tax unless the IRS has granted a hardship exemption.

A qualified personal residence trust is another device that can be used to transfer property at a tax discount. To implement this strategy, you convey your home into the trust, and you name a beneficiary that will inherit it after certain period of time elapses.

You stay in the home as usual for a term that you prescribe when you draw up the trust. Since the home is owned by the trust, it would not be part of your estate for tax purposes, but the transfer to a beneficiary will be a taxable act of gift giving.

The IRS calculates the value of the gift in light of the fact that the home will not be available to the beneficiary for a number of years. Since no one would buy a house at full value if they could not control it for 10 or 15 years, the taxable value is less than the full market value.

Another possibility is a generation-skipping trust. You would make your grandchildren the beneficiaries of the trust, skipping your children. This sounds like a punishment, but there is a tax benefit.

Your children would still be able to use property that is owned by the trust, they would receive distributions of the trust’s earnings. After the death of the children, your grandchildren would become the beneficiaries. The estate tax would be a factor, but there would be one round of taxation over two generations.

Schedule a Consultation Today!

These are a few of the trusts that can be used if you have estate tax concerns, and there are others. We can help you implement a wealth preservation plan if necessary, and we are here to help if your estate is not going to be subject to taxation.

You can schedule a consultation at our estate planning offices in Westport or Glastonbury, CT if you call us at 860-548-1000. If you would rather send us a message, fill out our contact form and we will get back in touch with you promptly.


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