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There are many different facets to consider when you are engaged in your estate planning efforts. Transferring assets is not always as simple as an exercise in pie slicing. You should carefully consider the impact that a direct inheritance can have on each of your loved ones. If you act in a discerning manner, you can provide for each person that you love in the optimal fashion. With this in mind, we will look at the value of special needs trusts in this paper.

MEDICAID COVERAGE

You have probably heard of the Medicaid program. This is a health insurance

“A qualified domestic trust is a legal instrument that is used as an estate tax efficiency tool when certain circumstances exist. To understand the value of a qualified domestic trust,

you need some background about the federal estate tax.”

WHAT IS A QUALIFIED DOMESTIC TRUST?

PAUL A. KRAFT Indiana Estate Planning Attorney

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DEATH TAX

As you go through your life, the tax man is omnipresent. Each year you have to file your annual income tax returns, but the taxation does not stop there. You have to pay property taxes, and there are capital gains taxes to contend with if you want to liquidate appreciated assets. There are taxes on purchases, and you pay taxes that are somewhat hidden, like gasoline taxes and taxes on things like alcohol, tobacco and hotel rooms. Since you pay all of these taxes throughout your life, you would naturally assume that the tax man would be satisfied after you pass away. Unfortunately, there is a death tax to contend with as well if you have been very successful from a financial standpoint.

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We have a federal estate tax, and it can significantly impact your financial legacy, because it carries a robust 40 percent top rate. You cannot give gifts to avoid the estate tax, because there is also a gift tax, and the two taxes are unified. The gift tax carries the same rate.

UNLIMITED MARITAL DEDUCTION AND UNIFIED EXCLUSION

The federal transfer taxes loom large for high net worth families. However, there is one bit of good news to report. There is a federal estate and gift tax marital deduction. You can use this deduction to transfer unlimited assets to your spouse free of

taxation, while you are alive, or after you pass away.

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The estate tax is potentially applicable on asset transfers to anyone other than your spouse.

When it comes to transfers to others, there is a federal transfer tax exclusion. The exclusion is the amount that can be transferred before the estate tax would become applicable. In 2015, the amount of this exclusion is $5.43 million. There are annual adjustments to account for inflation, so the figure will probably be a bit higher next year.

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CITIZENSHIP REQUIREMENT

The unlimited marital deduction is available to citizens of the United States. If you are married to someone who is not an American citizen, you cannot use the unlimited marital gift and estate tax deduction.

This stipulation is in place because a surviving spouse could return to his or her country of citizenship with a tax-free inheritance if the deduction was extended to non-citizen spouses.

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QUALIFIED DOMESTIC TRUSTS

Now that we have set the stage, we can explain what a qualified domestic trust can accomplish. You could use a qualified domestic trust to gain estate tax efficiency if you are married to a citizen of another country. To implement this strategy, you fund the trust, and you name a trustee to administer the trust after your passing. Your spouse would act as the first beneficiary, and you would name a final beneficiary (or beneficiaries).

If you do predecease your spouse, the trustee could distribute the earnings from the trust to your spouse throughout his or her life, and these distributions would not be subject to the estate tax. However, regular income taxes would be applicable. When you create the trust declaration, you can allow the trustee to distribute portions of the principal under certain circumstances, but these distributions would be subject to the death tax unless a hardship exemption was granted by the IRS. After the death of your surviving spouse, your final beneficiary or beneficiaries would inherit the assets that remain in the trust, and this transfer would be subject to the estate tax.

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SUMMARY

There are federal transfer taxes in the United States that can significantly erode your wealth as you are passing it on to your loved ones. These taxes carries a 40 percent maximum rate, and this is certainly an eye-catching figure. The good news is that there is an unlimited marital deduction. You can transfer unlimited assets to your spouse tax-free, as long as your spouse is an American citizen. If you are married to a foreign citizen, you could gain estate tax efficiency through the creation of a qualified domestic trust. Your surviving spouse could benefit from the trust throughout his or her life, but the estate tax would not be applied. To learn more about qualified domestic trusts and other estate tax efficiency tools, set up a consultation with a licensed estate planning attorney.

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REFERENCES

American Bar Association http://www.americanbar.org/content/newsletter/publications/law_trends_news_practice_area_e_newsletter_home/0501_estate_estateplanning.html Nolo http://www.nolo.com/legal-encyclopedia/using-qdots-plan-noncitizen-spouses.html

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About the Author

Paul A. Kraft

Paul Kraft is Co-Founder and the senior Principal of Frank & Kraft, one of the leading law firms in Indiana in the area of estate planning as well as business and tax planning.

Mr. Kraft assists clients primarily in the areas of estate planning and administration, Medicaid planning, federal and state taxation, real estate and corporate law, bringing the added perspective of an accounting background to his work. In addition to his practice, Mr. Kraft has lectured extensively in the areas of living trust planning, Medicaid planning, and presenting public and private seminars on the importance of proper estate planning. He has also authored various articles on estate planning and is a contributing author of LEGACY: Plan, Protect, and Preserve Your Estate–Practical Answers from America’s Foremost Estate Planning Attorneys. Mr. Kraft is a co-founder of the Indiana Network of Estate

Planning Professionals, a charter member of the American Academy of Estate Planning Attorneys and a founding member of the National Network of Estate Planning Attorneys. He is also a member of the Indianapolis Bar Association, including the Taxation, Business Law and Estate Planning sections; the Indiana State Bar Association, including the section on Taxation Law; the Indiana CPA Society; and the Estate Planning Council of Indianapolis. Mr. Kraft is admitted to practice law before the Supreme Court of Indiana, U.S. District Courts, and U.S. Tax Court.

Frank & Kraft A Professional Corporation Attorneys at Law www.FrankKraft.com 135 N. Pennsylvania Street Suite 1100 Indianapolis, IN 46204-2485 Phone: (317) 684-1100 Fax: (317) 684-6111