Protecting Assets from Taxes

While the options for protecting assets from taxation are becoming increasingly limited, it is still possible to prevent the IRS from becoming the main beneficiary of your estate.

Since most standard wills offer little tax efficiency or asset protection, it wise to consult a tax attorney to consider ways you can reduce your tax burden and protect your loved ones. While CPAs and other "tax professionals" can help you with financial planning, a tax attorney who is well versed in the law can provide an analysis of the various legal options available to you, review the costs and benefits associated with each option and help you devise an overall estate planning strategy that is best suited your individual circumstances.

Asset Protection Options

Navigating some of the most commonly used options may be more complex than first appears to be the case. For example, marital transfers, or bequests from one spouse to another, generally are not subject to estate taxes. However, upon the death of the receiving spouse, taxes will be levied on his or her entire estate, including the amount received as an inheritance from the first spouse. In this respect, marital transfers merely defer estate taxes; they do not eliminate them.

Trusts

One alternative is the establishment of a marital bypass trust (AB trust) or a qualified terminal interest property (QTIP) trust. Current laws on "personal exemptions" enable people to transfer the first $2 million of their estate to heirs without taxes. AB trusts are designed to ensure that the personal exemption of each spouse is used to the full extent possible while also ensuring that the surviving spouse will have full use of the trust assets during his or her lifetime. A QTIP trust permits a person to transfer assets to his or her trust while still maintaining control over the ultimate disposition of the trust's assets upon his or her spouse's death. These trusts are particularly popular among people who wish to reserve assets for children from a first marriage.

Gifting

Another effective way to transfer assets to your heirs while avoiding taxation is to use current provisions for lifetime gifts to children and grandchildren. Current tax laws allow individuals to make gifts of up to $12,000 a year to a person or persons—including most typically children or grandchildren—without incurring gift taxes. Moreover, if a husband and wife both engage in such gifting, they can collectively give away $24,000 per year per child or grandchild without incurring taxes. Over a period of time, the amount of money that can be transferred under this provision can be substantial. It also will reduce of the size of the final taxable estate.

If you have young children, you may wish to consider taking advantage of the uniform transfer to minors. Under the provisions concerning minor children, it is possible to make gifts to a custodian for the benefit of a child. These gifts are given to the child when he or she reaches the age of majority. As in the case of other lifetime gifts, the annual tax emption of up to $12,000 per year applies under this approach.

Life Insurance Trusts

Another instrument that can be used to exclude certain funds from an estate is the creation of irrevocable life insurance trusts. By transferring small amounts of money, equivalent to the amount of life insurance premiums, to an irrevocable life insurance trust, it is possible to not only reduce the size of a taxable estate, but also create a much larger asset, namely the amount of the life insurance proceeds. Amounts received from life insurance policies generally are not taxable.