Use It Or Lose It
In the horse trading for tax cuts, Washington may chop two
popular estate-planning gems
By Daniel Kadlec
With tax-cut fever running high, you may be surprised to learn that two popular estate-planning goodies could disappear as early as this fall. For most it won't matter because the $625,000 lifetime exclusion ($1.25 million if married with a bypass trust) and the ability to give as gifts as much as $10,000 per person per year provide adequate shelter from estate-tax rates that can rise to an onerous 55%. But if the bull market has swelled your estate to $1.5 million or more, consider these tax breaks now--before they vanish.
The most likely target is something called a family limited partnership. But also on the hook is what is known as a qualified personal-residence trust. President Clinton has said he wants both curtailed or eliminated, and while he may not get his way, there is no point in betting against him. Kevin Flatley, director of estate planning at BankBoston, advises clients to act by Oct. 1. That's when he expects a tax bill in Congress, and, he notes, "typically, changes like these are effective the date of the proposal." So don't delay on the assumption that you will have time after a formal proposal surfaces.
A family limited partnership effectively allows you to make a gift of assets at a discount of as much as 40% of their actual value, thus allowing you to give about $16,000 tax free per person per year--considerably more than the customary $10,000 limit. It works because the assets in a partnership, which has restrictions, are deemed less valuable than the same assets in an unrestricted account.
You can put anything in a family partnership, including the family business. For most, though, here's how it works: You designate a brokerage account and then stuff it with stocks, bonds and other securities. You are the general partner and sole stockholder; your heirs become limited partners. Each year you can give limited partners family-partnership stock valued at a maximum of $10,000. But remember, the partnership stock represents assets worth more than $10,000. Thus you shield a larger part of your estate. And if you're a control freak, the best part is that only you, the general partner, can liquidate assets. Hint: investment gains are taxable, so let the heirs cash out enough to pay the tax bite.
A personal-residence trust allows you to give away your house at less than its market value. It is best suited for a vacation house that you'd like to keep in the family for generations, but can be used with a primary residence as well. Here's how it works: You set up a trust and put the house in it, stipulating how long you will continue to live there. The IRS calculates the value of your remaining years in the house and subtracts it from the market value. Say your house is worth $500,000 and you stipulate a 12-year stay. The IRS says those years are worth $300,000. So in the estate your house is worth only $200,000. And here's the best part: 12 years later, the market value of that house might be $1 million. Yet in your estate, the value remains frozen at $200,000. You've shielded $800,000 from estate tax.
But be careful. If you have rotten kids, they can kick you out after the specified period. Hint: write in an option to rent the house as long as you like. Another catch is that you have to live the full term. Die early, and it's like the trust never existed. It works best for a vacation home because you're not parting with the house you live in and because heirs inherit the house at a low cost. And if they sell, they face a whopping capital-gains tax. Still, without the trust, estate taxes would claim an even bigger bite.
Facing the Ax
--Family partnership, which allows bigger tax-free gifts by discounting your assets as much as 40%
--Residence trust, which discounts your house's value and shields heirs from tax on future price gains