Tax Planning and Compliance

Tax Planning and Compliance

The Tax System

We pay all kinds of Federal and state taxes during our lives, including income taxes, sales taxes, property taxes, etc. After we pay tax, we accumulate our capital – our principal. At death, federal and state governments assess a tax on our principal. The government considers many things you may not expect as your principal for this purpose. For example, the death benefit of insurance, property such as a house, which you gave to children during life but which you continued to use, and retirement plans are all potentially taxed at your death. The federal estate tax is generally imposed at a rate of 40% of every dollar over $5,450,000 (20016) of wealth (our principal) transferred by gift or at death. Of every dollar we earn, in excess of 65% is potentially paid to federal and state governments in one form of tax or another.

The federal wealth transfer tax system is composed of a gift tax and an estate tax. The purpose of this wealth transfer tax system is to redistribute wealth to the general population through government programs. Subject to several exceptions, you cannot avoid the estate tax on your death by gifting property away during your life. All taxable gifts (those in excess of the annual exclusion) are added back into your taxable estate for purposes of calculating a tax on the total wealth transferred by you during life and at death, with a credit applied for any gift taxes paid. Gifts are not taxable if they meet certain criteria. Most people are aware of one gift tax exception – the $14,000 (2016) per year per donee exclusion – but there are several others and many ways to minimize gift and estate taxes.

Once you identify the egregious nature of the tax system, you may seek to avoid it. Doing so involves ways of reducing income and other life-time taxes and tax-advantaged shifting of wealth to children and grandchildren, often while securing your lifetime financial security and cash flow. Through the use of various tax exemptions and planning opportunities, which are often wasted, tremendous tax savings and wealth preservation can be achieved over your generation and, with proper planing, future generations.

Justice Louis D. Brandeis of the United States Supreme Court said it this way:

"I live in Alexandria, Virginia. Near the Supreme Court chambers is a toll bridge across the Potomac. When in a rush, I pay the dollar toll and get home early. However, I usually drive outside the downtown section of the city and cross the Potomac on a free bridge.

If I went over the toll bridge and through the barrier without paying the toll, I would be committing tax evasion.

If, however, I drive the extra mile and drive outside the city of Washington to the free bridge, I am using a legitimate, logical, and suitable method of tax avoidance and I am performing a useful social service by doing so.

For my tax evasion, I should be punished.

For my tax avoidance, I should be commended. The tragedy of life today is that so few people know that the free bridge even exists."

Retirement Plans

Proper coordination of the distribution of retirement plan benefits with a trust provides the only means of accomplishing optimum tax planning and protection in many cases.  It is more and more common with estates to find one spouse owning or participating in a retirement plan that consists of more than 50% of a couple’s combined wealth. With individual retirement accounts (IRAs), for example, designating your spouse as a primary beneficiary without proper integration of those plans with trusts for the spouse's benefit can waste tax exemptions and lose protections. Proper coordination of the distribution of retirement plan benefits with a trust provides the only means of accomplishing optimum tax planning in many cases.

Decisions related to payment of retirement plan benefits to you during life are also very important. Retirement plans can become exposed to income taxes and estate taxes at the same time, and proper planning involves avoidance or reduction of many of these taxes. The frequency of payment (whether fast or slow) is also inextricably tied to these decisions and planning opportunities, and only with proper legal advice can you be assured of optimizing the effects of your retirement plan options and decisions. Decisions which may appear to create the best income tax result will often cause a substantial increase in estate tax, and vice versa.


Estate Tax Reduction Choices

The following is a tabular summary of estate tax reduction options. For more detail, see Estate Planning and Trust Services:

Gift-but do it wisely

Sell-offers retained control and cash flow, and freezes your estate. Can be accomplished without capital gains taxes.

Part Gift, Part Sale-the sale portion is generally the amount desired to be retained to preserve cash flow or to avoid adverse gift taxes and typically achieves leverage.

Valuation Manipulation-consider creating a family holding company, which can artificially reduce the value of your assets for estate tax purposes.

Charitable Giving-avoid tax and inefficient government spending of your wealth and accomplish personal philanthropic objectives.

Insure-insurance offers a means of providing an influx of liquidity into an estate and a hedge against a premature death.

Summary Of State Taxes


Many states have their own taxes. These include income, property, such as intangible, various types of death or wealth transfer taxes, and others. An inheritance tax is a tax on the right to receive wealth that is measured by the share of an estate that passes to a particular beneficiary. An estate tax is a tax upon the net estate of a decedent, and is based on the right to transmit property to the estate beneficiaries. Some states impose both.

A generation-skipping tax is a tax that is imposed on a transfer of wealth to a beneficiary that is two or more generations younger than the transferror, i.e., a grandchild. The tax is imposed because an estate tax is avoided on the next youngest generation, i.e., that of the parents of the grandchild; i.e., your children.

A gift tax is a tax on the right to transfer wealth to another during life. It is analogous to the estate tax at death and is an integral part of some, but not all, state tax systems. States imposing gift taxes are marked in yellow.

All states impose an estate or inheritance tax. The Federal government grants a credit against the Federal estate tax for state inheritance or estate taxes. To the extent a state tax paid is credited against the Federal tax payable, no additional taxes are paid. In essence, this is a Federal-state revenue sharing measure. The Federal credit, however, is limited. Some states impose taxes that exceed the Federal limit. The states indicated in red are those that impose a death tax that can exceed the Federal limit and can require the payment of taxes that are greater than the Federal credit. All other states will not exceed the limit and do not impose any additional taxes.

Similarly, some states impose a generation-skipping tax. These are marked in green. A Federal credit, similar to the Federal credit for state inheritance and estate tax, is available. No states impose a generation-skipping tax that will exceed the Federal credit.

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