Minimizing Estate Taxation

There are a number of estate planning methods that can be used to minimize federal taxes on your estate.

Giving away assets during your lifetime. Federal tax law generally allows each individual to give up to $11,000* per year to anyone without paying gift taxes, subject to certain restrictions. That means you can transfer some of your wealth to your children or others during your lifetime to reduce your taxable estate. For example, you could give $11,000 a year to each of your children, and your spouse could do likewise (for a total of $22,000 per year to each child). You may make $11,000 annual gifts to as many people as you wish. You may also give your child or another person more than $11,000 a year without having to pay federal gift taxes, but the excess amount will count against the amount shielded from tax by your applicable credit. For example, if you gave your favorite niece $33,000 a year for the last three years, you would have reduced your applicable credit by $66,000 (a $22,000 excess gift each year).

The marital deduction shields property transferred to a spouse from taxes. Federal tax law generally permits you to transfer assets to your spouse without incurring gift or estate taxes, regardless of the amount. This is not, however, without its drawbacks. Marital deductions may increase the total combined federal estate tax liability of the spouses upon the subsequent death of the surviving spouse. To avoid this problem, many couples choose to establish a bypass trust.

Bypass trusts or credit shelter trusts can give a couple the advantages of the marital deduction while utilizing the unified credit to its fullest. Let's say, for example, that a married couple has a federal taxable estate worth $2 million (or $1,000,000 each). Using the marital deduction, if one spouse dies in 2003 the full $1,000,000 can be left to the other spouse without incurring taxes. However, when the second spouse dies in 2004 and passes his or her $2 million estate on to their children, taxes will be levied on the excess over the amount of assets shielded by the applicable credit ($2,000,000 - $1,500,000 = $500,000 subject to estate tax).