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Q: How do I know if I need estate tax planning?  


The federal estate tax law is always changing. The federal estate tax is computed as a percentage of your net estate. Your net taxable estate is comprised of all assets you own or control minus certain deductions.  Such deductions can be for administrative expenses such as funeral and burial costs as well as charitable donations. 


Q:  What is the current federal estate tax law?


A federal estate tax is levied on the transfer of money and other assets to your heirs after your death. This is known as an estate tax. It is also sometimes called the death tax. In 2011, the federal estate tax exemption was raised to $5 million and indexed for inflation. It has continued to rise each year. For people who die in 2024, no estate tax is due unless the total estate, including life insurance and IRAs, exceeds $13.61 million. The tax rate for estates over exemption amount is a flat rate of 40 percent. The federal tax exempt amount is called the applicable exclusion amount. We sometimes refer to it as a “coupon” which allows you to pass up to the exemption amount to others without the payment of any federal taxes. In addition to the applicable exclusion amount, a married person can leave an estate of any size to a spouse, provided the spouse is a U.S. citizen. This is called an “unlimited marital deduction.” Because estate taxes are due within nine months of death, a failure to plan for estate taxes can lead to a lack of liquidity and forced sales of assets.


Q:  Is the amount that my spouse and I can pass tax free automatically doubled?


"Portability" is the legal term that allows a surviving spouse the option to obtain the Deceased Spouses Unused Exemption Amount (DSUEA), effectively doubling the amount of wealth that can be passed by a married couple to their heirs. In order to elect portability, a surviving spouse must file an estate tax return, IRS Form 706, within 9 months of the death of the first spouse. Filing a Form 706 typically requires the assistance of a CPA and/or attorney. A couple can also make use of trusts at the death of the first spouse to assure that they maximize their tax exemptions. Such trusts have different names in the estate planning industry, such as A-B trusts, Family Trust, Credit Shelter Trust and Bypass Trust. Pratt Law is happy to teach you more about these trusts and help you decide if they should be used in your estate plan.


Q:  If my estate is under the Applicable Exclusion Amount, do I have to worry about estate taxes?


You will not have to worry about federal estate taxes if your estate is under the Applicable Exclusion Amount in the year of your death. In 2015, that amount is $5.43 million. This amount continues to rise each year with inflation. Many people are unaware of everything that should be counted as part of their estates for tax purposes. In calculating the size of your estate, you must include the total value of your life insurance policy proceeds, all retirement plans, the fair market value of all real and personal property, and any inheritances. It is also important to consider the effects of inflation and the future growth of your estate. Finally, if you are living in a state that has established its own estate tax, you retire to such a state, or own real estate in such a state, your family could be subject to state estate or inheritance taxes there.


Q:  Does California have an estate tax?


California presently has no estate tax, but that may change in the future. Even if you believe that that you may not be affected by the federal estate tax, you still need to be aware that you may be subject to state estate and inheritance taxes if the California tax laws change.  


Q:  Can I avoid estate taxes by giving away my assets now?


Gifting can be an effective way to avoid future estate taxes, with certain limitations. Federal tax laws allow you to give $14,000 per year (subject to adjustments for inflation) to an unlimited number of people without creating any gift or estate tax problems. A husband and wife may jointly gift $28,000 per year, per recipient. Annual gifts that you make in excess of $14,000 per person will not immediately be taxed. Instead, such gifts will reduce your Applicable Exclusion Amount ($5.43 million coupon in 2015) available at your death. You may give a total of $5.43 million in gifts to individuals during your lifetime. A husband and wife may give a total of $10.86 million and use up all of their exemption with lifetime gifts. Gifts are valued for tax purposes at the time the gifts are made. Therefore, future appreciation in the value of the gifted property will not be part of your estate. You may also give unlimited gifts to qualified charities during your lifetime or at death without gift or estate tax consequences.


Q:  Can life insurance be used to pay estate taxes?


Life insurance which is owned by you will be included in your estate for estate tax purposes. Therefore, although life insurance can be used to provide liquidity to pay taxes, the life insurance proceeds themselves will also be taxable unless you do not own the policy at the time of your death. The ideal way to use life insurance proceeds to pay taxes, but still maintain some degree of control, is to use an Irrevocable Life Insurance Trust (ILIT). The ILIT can own policies on your life. Premiums are paid by the trustee with gifts you make to the ILIT. Because the ILIT is an irrevocable trust and you do not own the policy personally, the death benefits may be excluded from your taxable estate. This means that the entire death benefit can provide the liquidity to your estate to pay taxes. The use of an ILIT can be a very effective and economical way to pay estate taxes with non-taxable dollars.


Q: What is a Credit Shelter or A/B Trust and how does it work?


A Credit Shelter Trust, also known as a Bypass or A/B Trust is used to eliminate or reduce federal estate taxes and is typically used by a married couple whose estate exceeds the amount exempt from federal estate tax. In 2015, the estate tax exclusion is $5,430,000. Because of the Unlimited Marital Deduction, a married person may leave an unlimited amount of assets to his or her spouse (who is a U.S. citizen), free of federal estate taxes and without using up any of his or her estate tax exemption. However, for individuals with substantial assets, the Unlimited Marital Deduction does not eliminate estate taxes, but simply works to delay them.  This is because when the second spouse dies with an estate worth more than the exemption amount, his or her estate is then subject to estate tax on the amount exceeding the exemption. Meanwhile, the first spouse's estate tax credit was unused and, in effect, wasted. The purpose of a Credit Shelter Trust is to prevent this scenario. Upon the death of the first spouse, the Credit Shelter Trust establishes a separate, irrevocable trust with the deceased spouse's share of the trust's assets. The surviving spouse is the beneficiary of this trust, with the children as beneficiaries of the remaining interest. This irrevocable trust is funded to the extent of the first spouse's exemption. Thus, the amount in the irrevocable trust is not subject to estate taxes on the death of the first spouse, and the trust takes full advantage of the first spouse's estate tax credit. Special language in the trust provides limited control of the trust assets to the surviving spouse which prevents the assets in that trust from becoming subject to federal estate taxation, even if the value of the trust goes on to exceed the exemption amount by the time the surviving spouse dies.


Q: What is a Qualified Personal Residence Trust (QPRT) and how does it work?


Our homes are often our most valuable assets and one of the largest components of our taxable estate. A Qualified Personal Residence Trust, or a QPRT (pronounced “cue-pert”) allows you to give away your house or vacation home at a great discount, freeze its value for estate tax purposes, and still continue to live in it. Here is how it works: You transfer the title to your house to the QPRT (usually for the benefit of your family members), reserving the right to live in the house for a specified number of years. If you live to the end of the specified period, the house (as well as any appreciation in its value since the transfer) passes to your children or other beneficiaries free of any additional estate or gift taxes. At the end of the specified period, you may continue to live in the home but you must pay rent to your family or designated beneficiary in order to avoid inclusion of the residence in your estate. This may be an added benefit as it serves to further reduce the value of your taxable estate, though the rent income does have income tax consequences for your family. If you die before the end of the period, the full value of the house will be included in your estate for estate tax purposes, though in most cases you are no worse off than you would have been had you not established a QPRT.  An added benefit of the QPRT is that it also serves as an excellent asset/creditor protection vehicle since you no longer technically own the property once the trust is established.




Any tax advice contained in this website is not intended or written to be used, and it cannot be used, for the purpose of avoiding federal tax penalties that may be imposed upon the taxpayer or for the purpose of promoting, marketing or recommending to another party any tax-related matters (IRS Circular 230).

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