Level 1: Revocable Living Trust (for some)
If you answer 'yes' to each of these questions, each spouse or partner should sign a revocable trust.
And each trust should contain an estate tax provision. The trust should whomever is the trustee on your death to set aside a separate account at your death.
The amount is the 'exempt' amount. After your death, the trustee in charge of that account uses it for you spouse, partner, or children.
Let's call this separate account the Family Trust (FT).
The estate tax goal is to keep the FT assets out of the surviving spouse (partner) estate at their later death.
So the first million is not taxed at either the first or second death. And $11.7 million (Federal, 2021) is similarly not estate taxed at either death either.
The design is usually like this.
1. Income. All income to spouse.
2. Principal. Principal to spouse and descendants for their health, education, maintenance, and support.
3. Death of beneficiary. Subtrust ends with death of surviving spouse. Assets go to children, equally, or to their descendants.
Health, education, maintenance, and support. This is broad. This language directs the trustee to distribute money to a beneficiary. How much? To let them continue to have the same style of living as the beneficiary enjoyed before the death.
Can the trustee be the same person as the beneficiary? Yes, but you need to include precise language in the trust document.
Can the surviving spouse be both the trustee while also being the beneficiary? Yes. This is common. It's what most people want and is frequent found in living trusts.
Step 2 (Level 2 of Estate Tax Planning): Remove existing life insurance from estate taxes
you face MA estate taxes. If so, you should ponder adding Level 2 to your estate planning.
Many people say that 'isn't life insurance free of taxes?' Yes, to some degree but not for estate tax purposes.
Yes, it is free from income taxation. Why? Because the federal tax law includes a section. And that section eliminates income tax on life insurance proceeds.
But life insurance is not free from estate tax. Let me explain.
If you name a friend (non-spouse) to receive the life insurance money, the amount will be included in your taxable estate. Because on your death bed, you had the power to change who receives it. That is, to change the beneficiary.
If you make your spouse the beneficiary, it will not be taxed because of the marital deduction.
Here's the problem. If you leave it to your spouse, it will be subject to estate tax in your surviving spouse's estate when they later die. So the proceeds do get estate taxed. Only later, as part of the surviving spouse's estate.
By the way, some people make this mistake. They surmise that because life insurance does not pass through probate to conclude it is not part of your taxable estate. Yet those are two different concepts. Probate is probate, taxation is taxation.
How to remove life insurance from estate taxation?
To remove life insurance proceeds from estate tax at your death and your spouse's death, you can do this:
Transfer the life insurance policy to a separate trust. Now. As a second level of estate tax planning.
Because you do not own the policy at your death it isn't part of your taxable estate.
IMPORTANT: Because the insurance proceeds are not put into your spouse's sole name, that money is not estate taxed on their later death. Instead the money is in a separate trust.
Yet that type of trust is not a revocable trust. It's an irrevocable trust.
Using an irrevocable trust in this way is not unusual. It's used so often that it even has its own, the 'irrevocable life insurance trust.' Or ILIT for short.
There are two requirements:
First, you must change both the owner and beneficiary of the policy to be your ILIT.
Second, you must live 3 years after the transfer of the policy before you die. Take both these steps and you reduce the family's estate taxes.
Step 3 (Level 3 of Estate Tax Planning): Gifting
Some people can't use Level 1 or Level 2 planning. They're not married and have no large life insurance to remove from their estate.
So, if that's you or if you've already adopted Level 1 and Level 2 planning, and still face MA estate taxes, you can consider gifting.
After you make a gift, your death estate is lower. That is, there is less in your estate because you gave some of it away. Because the MA estate tax is based only on your death estate, the estate tax is lower.
Non MA real estate. You should know that real estate outside of MA is not taxable as part of your MA estate. This is important. So a gift of NH real estate, for example, will not lower your MA estate tax. And because NH estate tax doesn't exist, choosing NH real estate to gift does not lower your MA estate tax.
Gifting comes in many forms. These include gifts of money, gifts of real estate, gifts of property like cars.
Gifting outright, gifting in trust form. There are different formats for gifting. There are direct, outright gifts. The recipient owns the asset in their own name.
Or, instead, you can make a gift in trust form.
Gifts in trust allow you to control the distribution of the asset after your death. While still lowering your estate by making lifetime gifts.
Unlike a revocable trust, this type of trust must be an irrevocable trust. And you cannot be the trustee.
Until the trust ends, the trustee decides when to distribute money to the beneficiary. By the way, the beneficiary is the person you want to make the gift to. There can be more than one beneficiary. And there can be more than one trustee. You can name two people together to be trustees.
$15,000 gifts. Many people know that you can make a $15,000 gift to another person without paying a gift tax. They think this is the largest amount you can make as a gift without paying a gift tax.
But, this is not true. You can give much more than that without paying a gift tax to the IRS. It is the IRS that has a gift tax, not the state of Massachusetts.
The IRS rules say that you can give $15,000 without preparing and filing a gift tax return.
But you can ALSO give up to $11.7 million (2021) without paying a gift tax. Filing a gift tax return is not that hard. It is called a 709 form.
Large gifts. You can lower your MA estate tax by making not only $15,000 gifts but also large ones. Much larger ones.
For example: You are single with $2 million dollars. You're somewhere between 70 - 90. You're single.
If you make a gift of say $400,000 to an adult child, you will not pay any gift tax. Because it is under $11.7 million. You will have made a gift of $400,000 minus the $15,000 that is exempt from gift calculation. So the gift is $385,000.
When you die with $400,000 less (due to the gift), your MA estate tax is $1.6 million. And the MA estate tax is lower. Because the MA estate tax return (M706) calculates the estate tax on the size of your death estate. Not the amount you once owned.
Another way to lower your estate tax bill is to give or leave, at your death, money to charity. Your estate will be able to deduct any charitable distributions from your taxable estate and so lower the size of your taxable estate.
Estate tax will be lower.
As I write this, I am listening to a podcast about food banks during the Covid 19 pandemic. Jobs were lost and families needed food for both adults and children.
All are embarassed by their situation of waiting on line. A private foundation provides the money for the food.
Mostly volunteers are on their feet for 9 hours. Trying to get the food in to the site, and out. Each day.
You can leave money, above the amount exempt from MA estate tax, to a charity or two. If you do not have obvious beneficiaries, or even if you do, you might want to search your gut for a charitable impulse.
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