This column first appeared in the San Antonio Express-News on September 9, 2015.
Dear Mr. Premack: We own a few properties in Austin and hope to minimalize the estate taxes. Our current net worth is about $15 million. We have three children ages 20, 17 and 14 for whom we have already set up a Trust funded with about $3 million. My husband and I hope our estate will grow and think it will reach close to the $30 million estate tax limit amount by the time we die. Of course this limit amount may change by that time. Our CPA says one thing. Our current lawyer says another. Would it be better to change our Trust and set up a Partnership instead? MN
Whoa. Back up a step. I know you want to avoid estate tax, but there is no $30 million estate tax limit. Historically, assets valued at over $675,000 were subjected to a 50% estate tax after the second spouse died. Starting in 2000, Congress allowed the exemption to rise, first to $1 million and eventually to $3.5 million. In 2012, the exemption was raised to $5 million, and it has since been increased to $5.43 million.
The $5.43 million exemption is “per person” and is portable between spouses if the correct legal planning steps are taken. Consequently, you and your husband could pass $10.86 million to your heirs free of estate tax. The excess would be taxed at the current 40% rate.
You mention a Trust established for your children. If it was established properly and is an Irrevocable Trust in which you maintained no ownership interest, then the value is removed from your taxable estate. All the growth the trust experiences is outside your taxable estate. However, the gift from you to the Trust may have utilized part of your lifetime gift tax exemption, and may have an impact on the estate tax exemption that is available when you die.
You expect your estates to continue to grow, and ask if a Partnership is a better approach to save estate taxes. The Partnership you refer to is a “Family Limited Partnership”, which is an overly complex and often unreliable approach. The reason it can save estate taxes is because it places so many complex restrictions on the assets that the IRS grants a discount in the asset’s valuation.
For example, you may own real estate worth $15 million. If you place the real estate into a Family Limited Partnership, all of its complexities may justify valuing the real estate at $12 million (ballpark) when you die. That $3 million discount would result in estate tax savings of about $1.2 million. However, you must be aware that the IRS does not like to grant these discounts. Using a Family Limited Partnership is an invitation to the IRS to perform an estate tax audit after you die.
Are there any other approaches you could utilize? Yes, but all the approaches involve a loss of control over the principal at some date. For instance, you could establish a new Charitable Trust or utilize an existing Charitable Trust that was already set up by your favorite charity. The Trust could provide an income stream for you, and even for your children after you die. But at some point, the principal would become the property of the charity. Your children could never access the principal and could never spend the principal.
Another approach is to establish a tax-exempt charitable Foundation, a tactic sometimes utilized by the very wealthy. It allows you to dictate the charitable purpose for the Foundation and to have some control over the distributions from the Foundation to achieve the charitable goals which you selected. If done properly, the Foundation could eventually employ your adult children and pay them wages, on condition that they provide valuable and real services to the Foundation. Other approaches may suit you better, so a personal consultation with your estate planning attorney should be scheduled.
Paul Premack is a Certified Elder Law Attorney with offices in San Antonio and Seattle, handling Wills and Trusts, Probate, and Business Entity issues. View past legal columns or submit free questions on legal issues via www.TexasEstateandProbate.com or www.Premack.com.