This week I’m sharing a blog on Medicaid from Dave Zumpano, who focuses in Medicaid planning. I’ll be sharing Medicaid blogs from Dave Zumpano monthly in this space.

Now, here’s Dave’s blog:

Blog Author: David J. Zumpano, Esq, CPA, Co-founder Lawyers With Purpose, Founder and Senior Partner of Estate Planning Law Center

Recent statistics indicate only 2 out of 1,000 clients have a federal taxable estate. While it affects only two‑tenths of a percent of the population, it is something attorneys come across that creates confusion in how best to plan. So, the first question to consider is how much over $10 million dollars a client’s estate is, which will dictate the type of planning strategy to use. Generally, there are three estate tax planning strategies utilized. One strategy is to utilize annual gifting to maintain the client’s current asset level. This approach is effective for those who are just below or just above the limit and have sufficient number of beneficiaries to gift the excess each year.  The second strategy is to “freeze” the value of a client’s estate at its current value so that all further growth of the estate happens outside the estate. This strategy is typical when a client has assets that are expected to grow aggressively. And finally, the third strategy is to reduce or eliminate taxes for individuals who are over the $10 million limit significantly. Let’s examine each approach.

Strategy One: Clients attempting to maintain their current estate can do outright gifts utilizing an estate tax focused irrevocable trust. This trust utilizes the “Crummey Power” to use the client annual gift exemption of $14,000.00 per person per year. Assets funded are removed from their estate. A critical distinction for this type planning is that the individual has enough beneficiaries to distribute the growth in their estate each year. For example, a typical $10 million estate that grows 5 percent a year would need to dispose of $500,000.00 each year. That would require 36 beneficiaries to distribute $14,000.00 to each year (or on their behalf to a Crummey trust) or 18 beneficiaries if the client is married and both husband and wife distribute each year. If the client does not have enough beneficiaries to distribute to, then maintaining the size of the estate using this approach, will be difficult. The attorney, however, can’t approach this planning in a bubble and must look to the type of assets in the estate to determine how rapidly it appreciates. For example if $5 of the $10 million is real estate that increases minimally in value or maintains its value given the current real estate market this strategy. The strategy may allow the client to maintain their current value but if you believe the real estate (or other assets, like a business) are going to appreciate significantly you may want to consider the second approach.

Strategy Two:  The second strategy is to freeze the estate value by conveying away to a trust or other entity assets currently owned by an individual and utilize a client’s lifetime gift tax exemption (same as estate tax amount). This strategy ensures all future growth on assets transferred will grow outside of the client’s estate. A business owner client with a company currently worth $2 million, but the client believes might be worth $5 to 10 million in a few years, would benefit from utilizing part of their lifetime exemption now (the $2 million dollar value) in conveying away business ownership so when it grows to $5 or $10 million, it’s outside their taxable estate. The same is true of investment-based assets that a client expects to grow. This strategy may require the client to forever give up all rights to their assets, but depending on legal documents used, the client may be able to maintain control and even derive the benefit from their assets by use of promissory notes and management fees. A technique to add to the freeze approach is to utilize discounting techniques that currently achieve a 30 to 40% discount on the value of any gift made. This allows individuals to convey away $5 to 10 million of assets but only have to use $3 to $6 million of their $10 million lifetime exemption. When combining these strategies, reduction by using discounting techniques also “freezes” the value of those assets that have been transferred in the transferor’s estate.

Strategy Three: The final strategy to eliminate estate tax is accomplished through the use of charitable strategies. Charitable strategies can be used during lifetime or after death to “zero out” the estate taxes if a client’s charitable intentions align with the planning strategy. Ultimately, if significant assets are conveyed to a charity the client has created (typically a private foundation) which the family still controls and benefits their community with. Charitable techniques can be used during life to reduce the estate tax and income tax! In addition, charitable planning through use of testamentary charitable lead trusts can reduce the estate to the maximum exemption and eliminate an estate tax.

So what do you want to do for a client over $10 million? I choose to focus on clients under $10 million as I find them to be more enjoyable and more open to the planning strategy and I co-counsel with attorneys that keep up with the technicalities of techniques to achieve the estate tax savings. The complication of advanced tax strategy requires a full focus by the attorney who understands the distinctions between these planning strategies and the overall goals of the clients. Be prepared to know these techniques or be able to worth with someone who does, if you intend to plan in this area.

Stephen C. Hartnett, J.D., LL.M.
Associate Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (800) 846-1555
www.aaepa.com