The Wall Street Journal reports that Twitter’s initial public offering documents reveal how the firm’s elite are using clever estate planning tools, such as GRATs and LLCs, which could considerably reduce federal estate taxes payable by their estates. Note that there are a variety of estate planning tools that may be used by almost anyone — not just the super-rich.
For the year 2013, a federal estate tax filing is required when an estate’s combined gross assets, together with prior taxable gifts, amount o more than $5,250,000 in value. Although this figure appears to be quite high, the proceeds of life insurance policies are deemed to be part of your estate for estate tax purposes, and this often takes heirs by surprise. An irrevocable life insurance trust (ILIT), for example, can help reduce or even eliminate these taxes.
How an ILIT works
Under the Internal Revenue Code (IRC), a life insurance policy is deemed to be part of your estate if you have any “incidence of ownership” over it. However, a policy that is completely owned by an irrevocable trust is not owned by you and, therefore, is not part of your estate. There are a few caveats:
- Once you have set up the ILIT, you cannot change your mind (although you can cease to fund it and let the life insurance policy expire).
- You cannot be a trustee of an ILIT that you create, which means someone else needs to be appointed to manage the trust.
- If you die within three years of transferring a policy you already own to the ILIT, the proceeds are deemed to be part of your estate — the three-year rule does not apply, however, if your trustee takes out a new life insurance policy on your life.
Paying the premiums
An ILIT can either be “funded” or “unfunded.” With a funded ILIT, you transfer an income-producing asset to the trust and the income is used to pay the premiums.
Unfunded ILITs are more common. With this arrangement, you pay the premiums by making cash gifts to the trust. In general, cash gifts not exceeding a certain value ($14,000 for the year 2013) per beneficiary per year are excluded from the federal gift tax. However, this exclusion only applies when the beneficiary of the gift receives a present interest, meaning that they have the ability to take the money for their own personal use when it is put into the trust. For this purpose, a “Crummey power” is used.
With a Crummey power, you transfer a cash gift to the ILIT. The beneficiaries are told that they may withdraw this cash gift within a limited time period if they wish, but if they do so, the policy premium won’t be paid. Once this time period has elapsed, the cash gift is used to pay the premium.