For All It's Worth
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In 18 months, Lara Villarreal Hutner's San Francisco law firm tripled in size, employing six attorneys who represent Frito-Lay, Pepsi, Wal-Mart and others. Villarreal Hutner, 39, estimates the value of her personal estate, including her firm, may reach seven figures by the year's end. "I just brought in Gap, MV Transportation and Staples," she says. "I can't even describe what's happened to my life." She hopes to transfer her wealth to her children when she and her husband pass away. But the federal estate tax says she must first hand more than 45 percent of every penny she owns beyond $2 million to Uncle Sam.
The estate tax has been debated in Congress for years. In 2010, it will disappear completely unless Congress re-authorizes it. But that shouldn't deter business owners from properly structuring their estates today to curb their exposure. "I'm going to act on information I have now," says Christine Fahlund, a senior financial planner at T. Rowe Price. "I'm not going to guess how it's all going to play out."
To minimize the effects of the estate tax on your assets, there are a few options:
Thanks to the unlimited marital deduction, "there's no tax on anything that passes to a surviving spouse," says Barbara Weltman, author of J.K. Lasser's Small Business Tax Tips 2008. (The same unlimited deduction applies to qualified charities.) "But when your spouse dies, then [the tax] hits the fan," she adds.
For protection, married individuals with assets exceeding $2 million each should establish individual credit shelters, or bypass trusts, as part of their wills and place up to the maximum exemption amount in each trust. It's one of the first steps Villarreal Hutner and her husband have taken to protect their wealth because a bypass trust effectively reduces the size of their taxable estate.
When one spouse dies, the surviving spouse has no control over the other's trust but can enjoy the investment gains from the trust, which may include a stock portfolio, rental property, cash or other assets, says Fahlund. It may be best to include income-producing investments in the trust, like corporate or municipal bonds and real estate investment trusts, suggests Anders Smith, vice president of wealth management services firm Nuveen Investments. Bypass trusts ultimately transfer to assigned heirs tax-free.
The Grantor Retained Annuity Trust is yet another tax-efficient way to take assets that are expected to appreciate over time, such as a business interest or a stock portfolio, out of an estate. A GRAT is an irrevocable trust that the grantor funds with assets; the grantor then receives a fixed stream of income from it for a certain number of years. Whatever's left in the GRAT after the designated time period goes to the beneficiary. "You can't go back and change it," says Smith. "So we recommend the individual speak with a financial advisor to address specific issues."
To make sure life insurance proceeds set aside for benefactors are excluded from your taxable estate, simply don't have the policy in your name, explains Weltman. One option is to set up an irrevocable life insurance trust, or to transfer ownership of the policy to the beneficiaries.
The annual gift tax exclusion gradually reduces the size of your taxable estate while you're alive. This year you can give away up to $12,000 per person tax-free. For couples, the maximum gift is $24,000 per person. With 529 college savings plans, individuals can gift on a faster track by investing five years' worth of contributions, or up to $60,000, in one year per beneficiary.