Estate tax efficiency is important for people who have accumulated significant stores of wealth. There is a federal estate tax in place, and here in the state of New York we also have a New York state estate tax.
The dividing line that separates those who must pay the tax from those who are exempt is the estate tax exclusion. There are two different respective exclusions for estate taxes on the federal and state levels.
Federally there is a $5.25 million exclusion in place as a result of provisions contained within the American Taxpayer Relief Act of 2012. This exclusion is adjusted annually for inflation, so it may be slightly higher next year.
The New York state estate tax exclusion is just $1 million. You may hear about a $5.25 million exclusion and think that you are in the clear, but the sources floating the $5.25 million figure may not be taking state-level estate taxes into account.
The estate tax is unified with the gift tax. This $5.25 million exclusion is applied to the value of your estate and the total value of any taxable gifts that you have given throughout your life.
However, when you give to charitable causes that are recognized by the Internal Revenue Service as being tax exempt the gift tax is not applicable.
As a result, in a general sense any tax exempt charitable donations that you make during your life are going to reduce the value of your estate and provide you with some estate tax efficiency.
You also get a charitable deduction for the year during which you make a contribution.
There are more advanced ways to give to charitable causes that can have positive tax consequences.
One of these strategies would be the creation of a charitable lead trust. These are rather complex, but we will endeavor to provide a brief explanation.
Charitable Lead Trusts
You as the grantor convey resources into the charitable lead trust, ideally highly appreciable securities. A charitable beneficiary that you choose receives payments from the trust throughout a prescribed term.
When you are creating the trust terms you include the selection of a non-charitable beneficiary. This beneficiary would become the owner of anything left in the trust after the term expires.
Because of the potential for a transfer of assets to a non-charitable beneficiary the gift tax is applicable. The IRS accounts for anticipated interest by applying the hurdle rate to the value of the trust.
If the trust appreciates at a rate that exceeds the hurdle rate over the course of its term this excess would pass to the beneficiary free of the gift tax.