The Federal Estate Tax is a transfer tax that an estate may have to pay before it can be distributed to its heirs or beneficiaries.  The estate tax must be paid within nine months from the date of death of a deceased person.  The estate tax is computed on almost everything owned by an individual at death.  This includes one’s home, business interests, bank accounts, investments, personal property, IRAs, retirement plans and death benefits from life insurance policies payable to or owned by the estate.  These items are reduced by one’s debts at death, expenses of administration of the estate (such as executor, legal, and accounting fees), certain medical expenses, funeral expenses, marital and charitable deductions and certain losses.  The value of the estate after deductions is subject to the estate tax to the extent it exceeds the exemption amount established by Congress and in effect at the time of death.  

In other words, a lifetime exemption against estate taxes is allowed to each individual and there is no estate tax on assets owned at death to the extent that the asset value does not exceed the exemption as of the decedent’s date of death.  In 2002, the exemption amount was $1,000,000 per person.  The amount gradually increased to $3,500,000 per person in 2009.  In 2010, the estate tax was temporarily repealed and then reinstated by the 2010 Tax Act. The American Tax Relief Act of 2012 set the exemption amount at $5,000,000, adjusted for inflation, and in 2017, the exclusion is $5,490,000.

The estate tax is a separate expense from income taxes and probate expenses, which also reduce the value of the estate passing to loved ones.  A married couple that have a combined estate greater than the exemption amount can reduce or eliminate estate taxes by ensuring that the exemption of both spouses utilized.  This is done by adding a Bypass Trust to your revocable trust, either with an AB Trust, an ABC Trust or a Disclaimer Trust, or by electing Portability after the first death. 


Gifts to spouses

As long as your spouse is a citizen of the United States, a gift of any amount may be given to him or her with no gift tax liability and no requirement to file a gift tax return.

Annual Gifts

A person may give $14,000 in cash or assets (based on the fair market value of the assets) to as many people as they wish per year.  Gifts which exceed this amount for any recipient must be reported by the donor on a timely filed gift tax return.  

Gift Tax Return

A gift tax return is required whenever someone makes a gift exceeding $14,000 to one person in any year (the annual exclusion), or makes a gift of a “future interest,” and is due on April 15th on the year after the gift is made.  The gift tax exemption is the same as the estate tax exemption, that is, $5,490,000 in 2017.  So if a gift is made that exceeds the annual exclusion, a return is required, but there will be no tax due unless the gift exceeds both the annual exclusion and the gift tax exemption.


The basis for capital gain purposes of property received by an heir is adjusted to the fair market value of the property as of the date of death of the decedent.  Thus, if David Smith gives at his death $10,000 worth of stock, that he purchased years ago for $3,000, to his daughter, Susan, it would get a new basis equal to the value on the date of his death, or $10,000.  Then, if Susan sells the stock for $10,000, she would use that new basis in the computation of her capital gain and there would be no income tax on the sale.  

This method of accounting, however, is not true if the stock was a gift made during David’s life, the recipient’s cost basis is the smaller of either the donor’s basis or the current fair market value.  If Susan sold the gifted stock, she must use her father’s cost basis of $3,000 and would realize a capital gain of $7,000.


Life insurance policies are considered part of the estate and are subject to estate taxes.  If an insurance policy is owned by an irrevocable trust, and if the beneficiary of the policy is also the trust, the insurance proceeds are removed from your estate for federal estate tax purposes.  This irrevocable trust also provides protection from creditors for the cash value of the policies during your lifetime and the policy proceeds when you die.


A QPRT lets you transfer a primary or vacation residence to a trust while you reserve the right to live in the home for a term of years.  The value of the interest you retain (that is, the right to live in the house for a term of years) is calculated using IRS tables.  The value of the property transferred into trust, minus your term interest’s value, is a gift known as the “remainder interest.”  This gift can be sheltered from gift tax by your gift tax exemption.  If you survive the term of years, the trust is not included in your estate for federal estate tax purposes.  QPRT’s may provide creditor protection by insulating the residence from your creditor’s claims.  


You create this trust during your lifetime for your spouse.  It qualifies for the gift tax marital deduction.  The federal estate tax benefit to this technique is that when your spouse dies, the QTIP trust is included in his or her estate for federal estate tax purposes, and if your spouse lacks sufficient assets in his or her own name to use his or her federal estate tax exemption, the QTIP assets will achieve this.

Upon the death of your spouse, if you survive him or her, an amount of assets equal to the estate tax exemption will first go to fund an irrevocable “family” trust created under the LIFETIME QTIP trust for your benefit.  The balance of the LIFETIME QTIP trust assets will be allocated to the “marital” trust for your benefit and will qualify for the marital deduction, resulting in no federal estate tax at your spouse’s death.

By structuring the LIFETIME QTIP trust this way, the assets allocated to the “family” trust when your spouse dies will escape estate tax because your spouse’s estate tax exemption “shelters” them from estate tax.  They also won’t be subject to federal estate tax when you die, because assets allocated to an irrevocable “family” trust are not part of your estate for federal estate tax purposes.

The LIFETIME QTIP trust also provides creditor protection because the QTIP assets are completely insulated from claims of your creditors and your spouse’s creditor’s during your spouse’s lifetime.


A CRT usually provides for distribution of a percentage of the trust principal, at least annually, to a person, usually the grantor, for his or her lifetime.  The CRT can provide that when the grantor dies, the grantor’s spouse shall become the CRT annuitant for his or her lifetime.  When this period ends, the charity receives the remaining CRT assets (the “remainder interest”).

Creating a CRT provides several income tax benefits.  For example, the grantor can deduct the remainder interest’s value (the interest passing to the charity) as determined at the CRT’s inception by consulting IRS tables.

An additional benefit is that the CRT is exempt from all income tax.  So a grantor owning assets subject to a large capital gain can transfer these assets to the trust, and it can sell them without the grantor or the trust having to pay any tax on the gain.  Or a grantor holding highly appreciated assets that aren’t producing much income can contribute them to the CRT and create an income stream and owe tax only as annuity payments are received.  It sells them and reinvests the proceeds to service the annuity.

A nondebtor-spouse-created CRT protects assets from a debtor spouse’s creditors.  A creditor can’t attach the principal because of the charitable interest.  And a debtor spouse’s creditors can’t attach the nondebtor spouse’s annuity payments.  If the nondebtor spouse dies first – and the CRT provides that the debtor spouse becomes the annuitant – the debtor spouse’s creditors could attach the annuity when distributed to him or her.


You create a CLAT by transferring cash, securities or interests in real estate, LLCs or partnerships, to an irrevocable trust during your lifetime or at your death.  A charity or your private foundation receives fixed annuity ( principal and interest) payments annually from the CLAT for the number of years specified in the CLAT.  At the end of that term, assets in the CLAT are transferred to non-charitable beneficiaries (typically children or a trust for children) specified in the CLAT.  

There are income tax charitable deductions available either upon formation, or annually as income is paid to the charity or foundation, depending upon whether the trust has been created as a "Grantor" trust or as a "Non-Grantor" trust.

Another advantage of the CLAT is that it allows a "discounted" gift to family members.  The value of a gift is determined at the time the gift is made.  The family member must wait for the charity's term to expire; therefore, the value of that interest is discounted for the "time cost" of waiting.

When the assets in the CLAT are transferred to the family member upon the expiration of the term, any appreciation on the value of the assets is free of either gift or estate tax.


A GRAT is a gift of a remainder interest in an irrevocable trust, under which the grantor has retained an annuity interest for a term of years.  For example, if $500,000 is transferred to a GRAT and the grantor has retained a 6% annuity, $30,000 per year will be distributed to the grantor.  The remainder interest in the GRAT can be a trust for the grantor’s spouse, with trusts being created for children when both spouses die.

The value of the gift to a GRAT for gift tax purposes is the value of the property transferred to it, less the value of the grantor’s retained annuity interest.  The value of the annuity is calculated according to IRS tables.

If the grantor survives the GRAT’s term, its assets will be excluded from the grantor’s estate for federal estate tax purposes.  If the grantor dies during the term, some of the assets will be included in the grantor’s estate for federal estate-tax purposes.


Family Limited Partnerships (FLP) or Limited Liability Companies (FLLC) are most suitable for individuals who have a business, real estate, a farm or ranch, or investments and have sound business reasons to own and operate such assets in the form of a business entity.  Properly used, FLPs and FLLCs can be of emmense benefit in directing the management of the business or investments, providing a procedure for the resolution of disputes, managing cash flow, providing an element of asset protection, and reducing estate tax by transferring interests in the entity to heirs.  

The following hypothetical illustrates the use of a FLLC:

A couple owns an apartment complex worth $3,000,000.  They have three children and would like to teach them how to manage the complex, and perhaps provide them with some cash flow.  They would also like to reduce their estate by making gifts to the children.  They give, say 10%, to each of the children, or to an irrevocable trust for the benefit of each child.

As the children develop, the couple intend to have them become more involved in management.  They decide to use the FLLC because this entity allows for the division of ownership and management.  A Limited Liability Company is managed by a Manager whereas a Limited Partnership is managed by a General Partner.  The couple decides that there are to be three Managers, which are to be both of them and the oldest son (who is currently involved in the operations of the complex).  The fact that the oldest son is a manager does not give him any additional percentage interest in the business, but allows him a voice in the management and, perhaps, compensation for his services.  As the couple age and the other children become more involved, the management structure can be easily altered to fit their needs.

The couple's 10% gift to each child is of the business interest.  It is not a gift of cash or of the underlying apartment complex.  This 10% LLC interest is not marketable, a child is not likely to find a buyer for a small percentage of a family business.  In addition, the child or the trustee of the irrevocable trust for the benefit of the child has limited voting rights.  The lack of marketability and control for the 10% interest reduces it's value to a hypothetical buyer.  This "discount" in value is appealing because more can be gifted tax free.  See the above discussion on estate tax and gifting.

It is oftentimes advisable to have the gift held by an irrevocable trust for the child rather than by the child individually.  This is very important if the child is a minor or otherwise unable to manage the asset but also provides the child with protection against law suits and failed marriages.  

FLPs and FLLCs are excellent tools but are complex and should only be organized by an attorney very familiar with the technique and the income, estate and gift tax effect of the formation and operation of the entity and gift of entity interests.


The term “dynasty trust” relates to the duration of the trust.  In theory, at least, the dynasty trust is intended to last in perpetuity or as long as the grantor of the trust has descendants.  It may be, however, that a shorter period, such as for the life of a child, will accomplish the creator’s objectives.  

Parents may provide in their revocable trust that, upon their death, their assets pass to the children and are held in trust for the benefit of each child for the child’s entire life.  Then, upon the child’s death, the assets pass to their children.  This may be considered a form of “dynasty” trust.  An individual may also create an irrevocable trust during his or her lifetime for the benefit of a child, and gift assets to the trust.  If the trust is for the life of the child, or longer, the trust may be considered as a “dynasty” trust.  

One purpose for establishing such a long term is to avoid estate tax upon the death of a child (this may also be referred to as a “generation-skipping” trust).  A parent establishes a trust for a child, either during their life or upon their death, and elects in a gift or estate tax return to utilize all or a portion of their generation skipping tax exemption.  Then when the child dies the trust assets pass to the child’s heirs without estate tax.  

Another purpose for such a long term might be that the child will never be able to manage assets because of an incapacity or inability.  If parents provide in a revocable trust that upon their death, the child’s inheritance is to be held in trust, the question is at what age the child will be sufficiently mature to competently manage the assets.  If the answer is never, because the child is a spendthrift, is easily influenced and lacks self determination, has substance abuse problems, suffers from a form of mental illness, or is developmentally disabled, the term of the trust would, by necessity, be for the life of the child.

It may be that the child has no need to be protected from their own indiscretions, but that the creator desires to arm the child with a degree of protection from the outside world.  A third purpose may be to insulate assets from claims of the child’s creditors or from spouses in the event of a divorce.  In such event, the child does not own the assets, the trustee holds title to the trust assets for the benefit of the child and the child may (or may not) possess a degree of control depending upon the extent of protection that the creator desires to achieve.

Under the laws of many states, including California, the duration of trusts is limited to a period measured by a complex rule called the Rule Against Perpetuities (essentially the lives of all beneficiaries, plus 21 years).  Today, a number of states (most notably Nevada, Delaware, South Dakota and Alaska) have enacted laws that eliminate or modify this rule and permit trusts that continue for very long periods, including trusts that may run “forever”.  If the purpose of the trust, however, is to address the needs of the child, rather than to span multiple generations, it may be sufficient for California residents to form the trust in California rather than incur the additional cost and complexity of forming the trust in another state.

A dynasty trust is a technique designed to allow its creator to pass wealth to successive generations of descendants with the distributions and operation of the trust being controlled by the terms initially established by the grantor of the trust.  


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Advanced Estate Planning Definitions

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