Inheritance: Leaving estates is all about tax choice

Taxes are optional. Contrary to the old saw about certainty and death and taxes, people expecting to leave large estates when they are gone have a choice about taxes. You can pay a lot of tax; you can pay a little tax; you can pay no tax. It all has to do with making choices while you are still young and alive.

In one of the more bizarre pieces of legislation in recent memory, Congress saw fit to slowly reduce the estate tax down to zero in 2010, and then restore it to its old levels in 2011. This little bit of trickery allowed the budget gurus to wildly understate the cost of the legislation.

The current estate tax law is so illogical as to be untenable. It has to be changed, and it will be changed. None of us can be certain about what the final estate tax structure will be.

It is my guess that some form of estate tax is here to stay. With the federal budget deficit forecasted to exceed one trillion dollars over the next several years, more tax cuts are going to be nearly impossible to pass. In addition, there is a rather powerful and compelling lobby in favor of some form of estate tax.

Those supporting the estate tax include nonprofit and religious groups and a consortium of prominent wealthy Americans. Some of the wealthiest, including Warren Buffet, Bill Gates, Sr. and Steven Rockefeller, are among those opposed to a repeal of the estate tax. When Warren Buffet speaks, everyone listens.

It is not my trade to argue for or against various taxes. My trade is to help people deal with taxes, generally by finding ways to pay the smallest amount. Actually, that is not quite true. What I really do is help people have the most money left over after they pay their taxes. That might or might not mean avoiding taxes.

When making plans for your estate, your options fall into a few neat little categories. The first step for most families is to have the surviving spouse inherit everything since there is no tax due. Generally, we are most concerned with the estate left by the second spouse since that is when taxes come into the picture. It is also when the heirs and charities start lining up at the lawyer’s office for checks.

The most basic and common choices in estate tax planning are:

  1. Give It Away. Give to heirs while you are alive and to charities now and when you are gone. If the estate is smaller, there is less to tax. If there is nothing in the estate, there is nothing to tax.
  2. Life Insurance. Life insurance proceeds are not subject to the estate tax as long as the insured is not the owner of the policy. In a sense, this is really another form of Give It Away. You give money to your heirs and they use it to pay for the life insurance.Each of these options further digresses into myriad combinations and structures such as trusts, family partnerships, foundations, annuities and other sorts of solutions. But at their core, all conventional estate planning strategies involve transferring assets out of the estate in one way or another while the patriarch and matriarch are still alive.

What every good estate plan has in common is the estate owner’s willingness to make hard choices now, and the willingness to give up some control of current assets. The gift of a life insurance policy to an irrevocable trust means that the donor can no longer change anything about the policy, such as the beneficiaries. Some parents cannot handle that lack of control, and hence choose to pay taxes instead of passing assets to children or charity.
Some parents are worried that their heirs will squander gifts made now, and so simply leave the assets to their heirs in their wills. Unnecessary taxes are paid, and the heirs still might squander the inheritance.

If you choose to avoid hard decisions and will not make difficult choices today, you will pay estate taxes. If you choose instead to confront reality and give up a little control, you can reduce or eliminate estate taxes. The result of a smaller tax bill will mean more assets for your heirs or for your favorite charity or both. Taxes are optional. The choice is yours.