In 1789, Ben Franklin wrote to French scientist Jean Baptiste Leroy, “Our Constitution is in actual operation; everything appears to promise that it will last; but in this world nothing is certain but death and taxes.”

In regards to death and taxes, nothing has changed in over two centuries. The only thing that has changed is nations have found a way to combine these two inevitable truths.

Imagine what old Ben would have said if knew that a couple hundred years later you would be taxed for dying. In fact, if you’re not careful, today your heirs could be taxed hundreds of thousands or even millions of dollars at your death.

This is why estate planning is so important. You should seek out a qualified estate-planning attorney to set up a plan if you are a U.S. citizen or resident and the total value of your estate — everything you own priced at fair market value — exceeds US$1 million.

Even if your estate is under US$1 million, you should still review your plan to ensure that your assets will pass to your intended beneficiaries after your death.

Poverty is One Easy Way to Avoid Estate Taxes

Yes, it’s true. One way to avoid estate taxes is to die poor, or at least not save enough wealth to be subject to estate tax.

In the United States, current law allows you to skip estate taxes if your estate is worth less than US$2 million. These minimums for taxation will rise to US$3.5 million in 2009.

Estates larger than these are taxed at a maximum rate of 45%. Moreover, the state where you live may impose additional estate taxes, which may significantly increase the effective rate.

But in 2010, something truly miraculous occurs: There will be NO estate tax (although the federal gift tax will still be in effect). So, if you’re wealthy and don’t want to bother with estate planning, just plan to die in 2010!

The bad news is that if you die after 2010, current law provides that starting in 2011, the estate tax returns to the 2002 taxation rates, of US$1 million. That means if your overall estate is worth over US$1 million, you can be taxed at a maximum tax rate of 55%. Ouch!

Think you can count on Congress to revise the law sometime between now and 2011? With a raft of unfunded obligations coming due for Social Security, Medicare, military retirement, etc., that would be a big mistake. After 2011, you should assume that the estate tax exemption will be US$1 million.

Don’t forget: If the bulk of your wealth is tied to your business, it’s generally required that your business is valued at its “highest and best use” for estate tax purposes. That virtually assures your business will have to be sold to pay this tax. It’s not uncommon for heirs to sell a business after the business’s founder dies and still owe hundreds of thousands or even millions of dollars in estate taxes!

To complicate matters even further, Congress also taxes money you give away. If you give away more than US$1 million during your lifetime (not including an annual US$12,000 allowance to each of your heirs), these “excess gifts” are taxed at rates up to 45% (55% after 2011). To add insult to injury, this lifetime exclusion decreases the estate tax exclusion on a dollar-for-dollar basis.

Estate Planning and Offshore Planning = A Happy Marriage

Fortunately, a variety of planning techniques are available to reduce or even eliminate estate taxes altogether. For Americans, and also for residents of “common law” countries, these techniques often involve various types of trusts, often paired with other devices (such as life insurance contracts) to “leverage” the applicable estate tax exclusion.

If you have an estate that’s slightly larger than the estate tax exclusion, a very simple trust doubles that exclusion for a married couple. It’s called an A-B or “credit shelter” trust.

Here’s how it works: Instead of willing your estate directly to your spouse, you each leave up to the amount of the estate tax exclusion to a trust (so this year, that would be US$2 million). Your surviving spouse can receive lifetime use and support from that property, but doesn’t own it outright. For that reason, those funds aren’t subject to estate tax when you or your spouse dies.

The simplest credit shelter trusts are created in a will or through domestic revocable living trusts. But it’s possible to incorporate this arrangement into an asset protection trust formed in a suitable offshore jurisdiction. That way, you and your spouse get the best of both worlds: You get state-of-the-art asset protection and a doubling of whatever estate tax exclusion is in effect.

Create an Eternal Family Legacy with an Offshore “Dynasty Trust”

At the other end of the spectrum, if you have a much larger estate, you should consider a “dynasty trust.” These are irrevocable trusts that are intended to last a very long time. In most states, your dynasty trust lasts 21 years after the death of your last beneficiary who was alive when you set up the trust (say your last child). But a few states (e.g., South Dakota) and many offshore jurisdictions have abolished this “rule against perpetuities.” In these jurisdictions, your dynasty trust can literally last forever.

As with most other types of trusts, there are generally no income tax savings when you create a dynasty trust. The IRS also taxes trust income, so many planners recommend your trust hold only tax-free assets like municipal bonds, life insurance policies, etc.

Instead, the tax savings occurs later, at your death, and subsequently, when your descendents die. With a properly designed dynasty trust, your children, grandchildren or great-grandchildren don’t have to pay gift or estate taxes on distributions. Moreover, since a dynasty trust normally has
“spendthrift” provisions to provide asset protection, the assets in your dynasty trust will be sheltered from the creditors of all trust beneficiaries, including those of succeeding generations.

One popular option is to create a dynasty trust as an irrevocable life insurance trust (ILIT). Your irrevocable insurance trust is funded with an insurance policy on your life. At your death, your insurance policy’s proceeds can actually pay any estate taxes on other assets in your estate. The cash value of the insurance policy and the death benefit will usually be much greater than the premium paid, so this is a powerful strategy to reduce or even eliminate estate taxes on your estate.

What’s more, if your children or grandchildren don’t need all of the trust’s assets, those assets can continue to grow and be passed down to their descendents — free of gift or estate taxes.

For More Information

Proper structuring of your estate-planning strategy requires substantial legal expertise. Be certain to retain a qualified attorney to put this strategy into place. Two attorneys, both members of The Sovereign Society’s Council of Experts, can assist members interested in exploring the possibility of forming a trust to save on estate taxes.

Michael Chatzky, JD
Chatzky and Associates
6540 Lusk Boulevard, Suite C121
San Diego, Cal. 92121
Tel.: (858) 457-1000
Fax: (858) 457-1007
Email: MGChatzky@aol.com

Gideon Rothschild, JD, CPA
Moses & Singer LLP
405 Lexington Avenue
New York, N.Y. 10174
Tel.: (212) 554-7806
Fax: (212) 554-7700
Email: grothschild@mosessinger.com

These two estate-planning ideas really are just the tip of the iceberg. If you’d like to know more about estate-planning trusts, see my February 2007 TSI article on our website at www.sovereignsociety.com

Mark Nestmann is a journalist with more than 20 years of investigative experience. The former
Editorial Director for The Sovereign Society, Mark now serves as a consultant to the Society. He is the author of many books and reports dealing with wealth preservation, international tax planning and offshore investing.