San Diego Estate Planning Attorney

Sometimes, a person’s estate may present issues that are not covered by the basic living trust estate plan. This section outlines some of the major estate planning techniques and the situations in which they are employed.

(1) Taxable Estates. If the decedent’s estate is large enough to have a substantial federal estate tax liability, there are a number of estate planning techniques that can be utilized to reduce the tax burden. Some of the commonly used ones are as follows:

(a) Irrevocable Life Insurance Trust. Contrary to popular belief, life insurance proceeds are generally subject to estate tax. However, if you create an irrevocable life insurance trust and transfer money to it each year for the trustee to pay the premiums on a policy on your life, and if certain other requirements are met, the life insurance proceeds payable to the trust at your death are not subject to federal estate tax. This has two significant impacts. First, the value of the taxable estate is reduced by the amount of insurance proceeds which are now not subject to estate tax. Second, sometimes the estate’s assets are illiquid, meaning that they are not readily convertible to cash. Common examples are real estate and closely held business interests. Yet, the estate tax on these assets is due nine months following the date of death. Without a ready source of cash, the trustee would have to either sell assets (potentially at distress prices, depending on market conditions at the time of your death) or refinance them so as to generate the cash needed to pay the tax. The life insurance proceeds payable to the life insurance trust provides a pool of cash that may be used to pay the tax, thereby avoiding the need to sell or refinance assets.

(b) Grantor Retained Interest Trusts. There are two types of grantor retained interest trusts. One is called a Grantor Retained Annuity Trust (“GRAT”). The other is called a Grantor Retained Unitrust Trust (“GRUT”). Both are irrevocable trusts. In each case, during lifetime, you transfer assets to the trust, but retain for your own benefit the Annuity or Unitrust interest. The Annuity interest in a GRAT is a fixed percentage of the initial fair market value of the assets transferred to the trust. The Unitrust interest in a GRUT is a fixed percentage of the fair market value of the trust assets, redetermined annually. While the transfer to the trust is subject to gift tax, the value is reduced by the actuarial value of the retained Annuity or Unitrust interest. Because of this retained interest the gift tax value is “discounted”. This means that a smaller part of the federal state tax exemption available for lifetime gifts is used, leaving more available to transfer assets at death. With the trust assets now outside the taxable estate, the federal estate tax obligation is reduced.

(c) Charitable Remainder Trusts. There are two types of charitable remainder trusts. One is called a Charitable Remainder Annuity Trust (“CRAT”). The other is called a Charitable Remainder Unitrust (“CRUT”). Both are irrevocable trusts. In each case, during lifetime, you transfer assets to the trust, but retain for your own benefit the Annuity or Unitrust interest. The Annuity interest in a CRAT is a fixed percentage of the initial fair market value of the assets transferred to the trust. The Unitrust interest in a CRUT is a fixed percentage of the fair market value of the trust assets, redetermined annually. When you die, the trust estate passes to the charity you designate in the trust. The charitable remainder trust provides tax benefits in addition to meeting your philanthropic goals. The actuarial value of the charitable remainder interest qualifies for a charitable donation deduction on your income tax returns. The trust is a tax exempt entity. This means that the trust can sell appreciated property without having to pay an immediate capital gains tax. When you die, the actuarial value of the charitable remainder interest qualifies for the estate tax charitable deduction.

(d) Family Limited Partnerships. The federal estate tax applies to the value of all assets owned by the decedent at the time of his or her death. Use of a family limited partnership can reduce the value of assets for tax purposes. A lower value means a lower tax. Suppose, for example, during his or her lifetime, the decedent transfers his or her real estate to a limited partnership in which he or she is a 1% general partner and a 98% limited partner with the children as 1% limited partners. For tax purposes, the value of a 98% limited partnership interest is less than 98% of the underlying real estate transferred to the partnership. Sometimes this “discount” may be substantial, resulting in a substantial discount of the estate tax liability.

(e) Qualified Personal Residence Trust. As the name implies, this technique may be used only with a person’s personal residence (or vacation home). In this plan, you transfer your personal residence to an irrevocable trust, but retain the right to live there for a specific number of years (not for your lifetime). The actuarial value of the retained term of years reduces the value for gift tax purposes. If you outlive the retained term of years, the value of the residence is outside your estate and not subject to estate tax when you die. If you die during the retained term of years, then the plan fails and the residence is included in your taxable estate. If you outlive the retained term, you either have to move to a new residence or rent the residence from the trust or beneficiaries of the trust.

(2) Special Needs Trusts. Sometimes a beneficiary is disabled and receiving public assistance benefits such as Medi-Cal (Medicaid) or Supplemental Security Income (“SSI”). These programs are “means-tested,” meaning that if the beneficiary has too much assets or income, he or she does not qualify to receive the benefits. If you die and leave an inheritance to a beneficiary who was previously receiving Medi-Cal or SSI, his or her continued eligibility for such benefits may be destroyed. However, by utilizing a Special Needs Trust, you can provide the disabled beneficiary with some benefits from your estate while still preserving his or her public assistance benefits. Basically, the Special Needs Trust allows the trustee to make distributions for the benefit of the disabled beneficiary as a supplement to, but not a replacement of, the public assistance benefits.

(3) Medi-Cal Eligibility. Suppose you are married and you need to go into a skilled nursing facility. The cost of such a facility can be several thousand dollars per month. Such an expenditure could leave your spouse impoverished. If you have assets, however, you won’t qualify for Medi-Cal. So, what can be done? In determining Medi-Cal eligibility, if you have too much assets, you must pay your own way until those assets are substantially exhausted, a result which you are trying to avoid. However, only certain assets must be liquidated. Other assets (called “exempt assets”) can be retained. One technique is to convert your nonexempt assets (e.g. cash, stocks and bonds) to exempt assets. In this way, your wealth is preserved, albeit in a different form, and you qualify to receive Medi-Cal benefits. The most significant exempt asset is your personal residence.