Klenk Law

Using an Irrevocable Trust to Reduce Estate Taxes

Posted on Mon Jul 11, 2011, on Trusts

The new tax rules for 2011 and 2012 increase the applicable exclusion amount that can be used to give away $5 million free of gift tax. This provides a unique opportunity to shift wealth out of your estate to your children or other heirs and a vehicle to reduce estate tax. By using an irrevocable trust the wealth can be protected from your children’s divorces, creditors and from estate and inheritance taxes when those same assets later pass to or in further trust for your grandchildren when your children die.

In short, instead of making a gift of assets to your children ranging in value from $1 to $5 million, you would instead have us form an irrevocable trust to which you would make the gift. The trust would own the asset, but if the correct language is used, the child can be both the beneficiary (the person who benefits from the broad language of the trust) and the trustee (the person who runs the trust). The key is that the trust owns the assets, not the child.

Because the trust owns the assets, the child’s marital or creditor issues have no effect on your gifted assets. We insert language that makes it clear that with few exceptions the child creditors cannot force the trustee to pay the child’s debts and the spouse is not able to demand that the assets be seen as marital assets during the divorce. Further, when the child dies the assets are not subject to estate or inheritance taxes as part of the child’s estate. Those taxes are levied on the assets the child owned…and the child does not own what is owned by the trust. This way the trust assets can pass to or in further trust for grandchildren without being reduced by these estate or inheritance taxes.

Another advantage of the irrevocable trust is that after the gift, the assets can be invested just as if the child owned the assets. The growth in value on the assets passes outside your estate, free of estate and inheritance tax. For example, if you put $1 million into the trust in 2011 and before you die that $1 million is invested and grows to $3 million, the $2 million in growth passes outside your estate, free of the federal estate tax (35% in 2011 and 2012) and inheritance tax (if you are a resident of Philadelphia, Pennsylvania, 4.5% if the beneficiary is a child or even higher if you are a resident of Camden County, New Jersey and assets pass to a niece); a substantial savings.

Using your gift tax exemption in tandem with an irrevocable trust can be a powerful estate-planning tool. The calculations can be complex and the trust document need be drafted correctly, but when done well it can lead to large savings when part of a proper overall estate plan. If you need assistance with an estate plan or have questions about irrevocable trusts or gift tax planning, please call one of our probate lawyers or estate planning attorneys for a free consultation.

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