Death and Estate Taxes

The old adage "you can't take it with you" is still true, but just about every other form of conventional wisdom in the field of estate planning has changed in the past five years. What was once considered dogma—give most of your money outright to your heirs—is now considered heresy, and what was once considered heresy—give your money away while you're alive—is now the prevailing view. The irony is that the hottest estate-planning techniques now have been around for a long time; it's just that people didn't recognize their value. "The solutions have been around for years," says Elizabeth Mathieu, president of Neuberger Berman Trust Company, which administers approximately $3 billion for high-net-worth clients, and the expert we consulted for this story. "But it is only now that people are beginning to take advantage of them. It basically is a matter of a change in attitude caused by an increase in available information and a new perception of wealth. People have become more sophisticated—including estate planners themselves."

In the following article we contrast the old and new ways of approaching five core issues of estate planning. (We've touched only lightly on trusts because they will be the subject of a future Moneyed Interests.) Throughout we've used the words spouse, wife, and husband in the examples as a matter of convenience. However, we want to make clear that, except where indicated, these scenarios also apply to individuals, to single parents, unmarried couples, and same-sex couples.

When To Give It Away

The Traditional Scenario Leave money and other assets to beneficiaries when you die through your will.
The New Approach Give away as much as possible during your lifetime—and the sooner the better.

"The first thing most people consider when it comes to estate planning is whether they'll have enough money to retire," says Mathieu. "That's a very personal amount. I know people who have $10 million and say they don't want to give away any of it now because they don't know if they're going to need it later. I also know people with $3 million who are giving it away like crazy."

There are a few good reasons to give away money while you are living. The first is to take advantage of the $10,000 annual exclusion, which allows you to give $10,000 per year to as many people as you like without incurring gift tax. In other words, you could give away $1 million in a given year without paying gift tax, as long as it is in the form of 100 gifts of $10,000 to 100 different people—and you could do the same year after year after year. "We have clients with twenty grandchildren who give $10,000 to each one each year," Mathieu says. "That's $200,000 in tax-free gifts. Sometimes they don't give cash. They look at their marketable securities portfolio, and if they're overweighted in a stock, they give it directly. That way, they don't have to sell it and incur capital gains tax. But keep in mind that when the grandchildren sell the stock they will have to pay capital gains tax." (If you are married, you can opt to "gift-split," which means you can write a check from your personal account for $20,000 and your spouse can claim half of it.)

The second reason to give away assets before death is that you don't incur any estate tax, which is levied on posthumous gifts and is much more onerous than the gift tax. For although the gift and the estate tax rate schedules are the same (18 to 55 percent), the gift tax is calculated only on the money given, whereas the estate tax is calculated on the money given plus the money your estate uses to pay the tax. "In other words, gifts given during your lifetime are tax exclusive, and gifts given after death through your estate are tax inclusive, which makes it much more expensive," Mathieu explains.

That's especially significant when it comes to unified credit. This credit allows you to give away $675,000 worth of assets tax-free during life or at death, with the amount rising to $1 million by the year 2006. (See graph.) That's in addition to the $10,000 annual exclusion. By giving assets away now, you leave less in your estate, thus ultimately lowering your estate tax.

The unified credit is particularly rewarding to married couples who have a minimum of $1,350,000 combined to present to heirs (in other words, $675,000 times two). The problem is when there's less than $675,000 in one spouse's name. "I see a lot of couples over the age of fifty in which the husband works and has $20 million in his name, and the wife doesn't work and has $400,000 in hers," states Mathieu. "When the wife dies, her estate doesn't own enough assets to use the full $675,000 of unified credit. In this situation, I advise them to move half of the assets—or, if that is not palatable, at least $675,000 in the form of cash, stocks, or tangible property—into the wife's name. If the couple plans to give money to grandchildren, I advise that they transfer at least $1 million to her name, because the Generation-Skipping Transfer Tax has approximately a $1 million exemption per person." (GST tax is discussed in detail later on.)

Mathieu also recommends that a couple create separate bank accounts. "The problem with joint bank accounts is that if people are married, the assets are considered half owned by each, whether they each contributed half or not," says Mathieu. "If people are not married, it just isn't clear how much of the account is in each person's estate. When the first person dies, tracing rules are applied to see who put the money in the joint account and therefore in whose estate the money belongs."

There is, however, an exception—if you die within three years of giving a gift, the IRS will include in your taxable estate the amount of gift tax you paid on that gift. Of course, the appreciation on that asset within those three years is out of your estate and thus not subject to estate tax.

Finally, giving away assets now keeps your estate from incurring the tax on the appreciation of those assets. Suppose, for instance, that you and your spouse take $100,000 and place it in a trust for your daughter. (For the sake of argument, assume that you have already used up all of your gift-tax exemptions, and are in the 50 percent tax bracket.) You pay $50,000 in gift tax on the $100,000 at the time of this transfer. Let's assume, too, that she lets the money appreciate and in 20 years it grows to $1 million. There's no gift tax owed on the capital gains. However, if instead you and your spouse invest the $100,000 yourselves for 20 years, then give your daughter the $1 million, the gift tax is $500,000.

"In the first scenario, parents give the money away early on so that the future growth is out of their estate," says Mathieu. "When they die, their estate won't pay estate tax on it and it will be sitting in a trust that their daughter can access for her benefit during her lifetime. If there's still money left over when she dies, and if it's structured properly, she can pass it on to her children in the form of a trust without worrying about GST tax, or it can go to charity. Of course, a capital gains tax will have to be paid on the appreciation of the gift when the daughter sells the stock, but that tax is at a far lower rate than the gift tax."

Who Should Advise You

The Traditional Scenario You hire a lawyer to draw up your will and trusts, an investment manager to manage your investments, and an accountant to prepare your tax returns—with no collaboration among the three.
The New Approach Integrate estate planning, tax strategy, and investment management by bringing your lawyer, accountant, and investment manager together to create one comprehensive plan.

"There is considerable interest in this now," says Mathieu. "In the past people kept their three advisors separate. Sure, they'd say to their investment manager, 'If you are going to sell my stocks, think about tax losses and gains and try to match them up. And they'd go to a lawyer who would tell them how to save tax if they created this trust or that partnership. The problem is that while the lawyer may have given good legal advice, he wasn't necessarily giving good—or any—financial advice. For instance, the lawyer may not have been suggesting that a trust for grandchildren be heavily weighted toward equities because it wouldn't be used for 20 years and could grow faster. And the lawyer didn't necessarily remind these clients to inform their investment manager about their decisions, when it was the investment manager who had to think about associated tax issues. At the end of the year, the clients told the investment manager to send capital gains reports to the accountant so that he could figure out the taxes, but that was it.

"Our clients who have integrated all three feel more secure now because they know that each advisor is working with the others. The client doesn't have to manage each advisor himself."

Not coordinating the three areas can also be expensive. "I had a client," says Mathieu, "who thought she had an irrevocable trust for her children, meaning that if she made a gift to it, it would be out of her estate. She had her lawyer draft the trust document, then she merrily made gifts to it over a ten-year period. When we got involved we had to tell her the trust was a revocable living trust and the gifts weren't effective—that is, they were still in her name. If we had been involved with the client early on, we would have detected the error. Instead, this client wasted ten years of what she thought was careful planning."

How To Leave An Ira To Your Spouse Yet Ensure That Your Children From A Previous Marriage Receive The Remainder

The Traditional Scenario You create an Individual Retirement Account (IRA) and name your second spouse as the primary beneficiary and the children from your first marriage as the secondary beneficiaries. When you die the IRA is either rolled over into your second spouse's IRA, which has its own beneficiaries, or your second spouse takes the distributions from it over his lifetime. Your second spouse can leave the balance to whomever he or she wants regardless of your wishes.
The New Approach You make the beneficiary of your IRA a Qualified Terminable Interest Property (QTIP) trust, also called a marital trust. Your second spouse is the primary QTIP trust beneficiary, and the children from your first marriage the remaining beneficiaries upon your second spouse's death. When you die the money from your IRA passes to your second spouse through the QTIP trust in the form of distributions. When your second spouse dies, your children from your first marriage automatically receive the balance.

The QTIP trust is a prime example, Mathieu says, of the way in which the use of trusts has changed dramatically in recent times. "Historically, people thought they were only for married couples in which one spouse was financially unsophisticated and needed a trustee to oversee investments," she says. "Today many people at all wealth levels are using them—for example, in conjunction with charitable gifts or IRA beneficiary designations. It's a revolution in the application of a concept that has been around for a very, very long time."

The QTIP trust can be used exclusively by married couples, and it is especially useful in cases where one or both members have children from a previous marriage, particularly when it comes to designating the beneficiary of an IRA. "In this instance people use the QTIP trust because they want to make sure their spouse is taken care of," remarks Mathieu, "and their children will receive whatever assets are left when the spouse dies."

There are two reasons the QTIP trust is better than simply designating family members as IRA beneficiaries. First, you ensure that your children will receive the assets of your IRA when your second spouse passes away, since the QTIP trust isn't part of your second spouse's estate. (Under the traditional scenario your second spouse could exclude the children of your first marriage from his estate.)

Second, the use of a QTIP trust permits your second spouse to take advantage of the marital deduction, which allows spouses to give each other an unlimited number of gifts while alive and after death without incurring gift tax or estate tax until after the recipient dies. (One important restriction: the recipient spouse of a QTIP trust has to be a U.S. citizen.) Ordinarily to qualify for this deduction, these gifts must be given solely to the spouse; they cannot be shared with other family members. They must also be unrestricted, meaning that the full amount is given outright to the recipient. "The QTIP trust is an exception to this general rule," says Mathieu. "It says that the living spouse has the right to get at least all income annually from this trust and the gift still qualifies for the marital deduction. This is a way of lengthening IRA distribution years, and securing tax-deferred growth for many, many years."

Even if you don't use the QTIP trust, designating your estate beneficiary of your IRA, and designating the recipients of the IRA assets in your will is worse than just naming IRA beneficiaries. "You've got to be very careful not to do this," says Mathieu. "When the IRA defaults to the estate it will pay 39 percent in income tax and 55 percent in estate tax on it, and in the end the beneficiaries may only get 23 cents on the dollar." (Don't add the percentages—the math might seem a little odd, but it's right.)

However, there is a potential snag with the QTIP trust: The interest and dividend income may not be enough for your spouse to live on. "The income can be as low as 1.8percent," Mathieu says, "which doesn't even cover real wealth, because inflation is running at three to three and a half percent per year. I actually do have clients who are getting 1.8 percent, and the kids are inviting them to live with them since they're the ones with the money."And that's why you should give your spouse the "right to invade principal"—that is, the right to withdraw the principal from the trust.

This scenario is particularly common in QTIP trusts that were created in the late 1970s and early 1980s, mainly on the interest from bonds. "Interest rates were really high, so bonds were generating income at 18 percent," notes Mathieu. "When people created marital trusts in those years they thought, 'Well, this trust will generate 18 percent income, so what else do I need to give?' Now average interest rates on bonds are at around five percent. A good advisor won't tell a trustee to invest in bonds because the trust will not grow. However, because the people who created those QTIP trusts have already passed away, there's nothing their beneficiaries can do now to change them—unless they can get a court to do so, which is expensive."

If you set up a QTIP trust as the beneficiary of your IRA, be sure to read the fine print of the IRA beneficiary form. "If you want the IRA to go to a trust, you have to deliver the trust document to the plan sponsor within ninety days," Mathieu explains. "Also make sure your IRA allows this. Some of the mutual fund companies won't accept a trust as a beneficiary."

How To Give Assets Yet Still Retain Control Of Them

The Traditional Scenario A couple sets up individual trusts for each beneficiary or creates a single trust that breaks into a trust for each one upon the couple's death.
The New Approach The couple sets up a Family Limited Partnership (FLP) or a Limited Liability Company (LLC) and makes the beneficiaries either limited partners or nonvoting stockholders.

Despite its name, the Family Limited Partnership isn't restricted to families. It can be set up by individuals, unmarried couples, or married couples, and include anyone as its beneficiaries. The same is true of the Limited Liability Company.

"We have about seventy clients who have set up FLPs for the first time," says Mathieu. "The limited partnership has been around forever. But using it for the family is only a few years old. For all practical purposes the FLP and the LLC are virtually the same thing, but in some states the LLC requires more paperwork to set up and maintain."

The advantages of both vehicles are twofold—you can give away assets to beneficiaries while you are alive yet still retain total control over the assets. In the LLC you can retain voting stock, with beneficiaries having only nonvoting interests. In the FLP you (and/or your spouse—or a corporation that youcontrol) can be the general partners, while the beneficiaries are limited partners (and receive limited partnership units). In both you decide the course of the business, including whether to pay out distributions. Moreover, like trusts, the FLP and LLC are separate legal entities and therefore are included in someone's estate only to the extent that the individual owns an interest in them.

From a tax standpoint there is an even greater advantage. "As limited partners the beneficiaries would have a difficult time selling the limited partnership units," Mathieu explains, "because no buyer would want to buy them. What would be the point? The buyer wouldn't have any right to direct what goes on in the partnership and couldn't do anything with the limited partnership units—not even get a loan against them."

That's important because the gift tax on the limited partnership unit depends upon its fair market value, which is normally less than the underlying capital. Says Mathieu: "Let's say you give me a limited partnership unit worth 10 percent of a partnership that has $1 million worth of stock. The value of the gift for gift tax purposes is its fair market value, or what a willing buyer would pay for it. You know that no buyer is going to pay $100,000 for it, so a fair price might be $60,000. If the IRS agrees, then you pay gift tax on $60,000 instead. So for tax purposes you begin to reduce the value of what you're giving away."

That's not to say the IRS will make it easy for you. "Valuation of limited partnership units is very controversial," Mathieu notes. "The IRS doesn't like greedy people. In other words, if you put $1 million of a Neuberger Berman portfolio in a partnership and give 50 percent to someone else, then declare on your tax return that you think the gift is worth only 20 percent, there is a good chance the IRS will audit you and disagree. There are limits to what the IRS will accept as reasonable."

There's also the issue of how many limited partnerships you should have and which assets you should use to create them. "I have seen discounts taken as high as 50 percent when people put art or real estate that is not very marketable into a Family Limited Partnership," Mathieu notes. "If you only put in marketable securities you're going to take less of a discount because they're very liquid. That's why some people suggest that you put investment management assets in one partnership and other types of assets in another. The problem is that sometimes the IRS questions this because it looks like you have established the partnership solely to manage your gift taxes, which is not allowed."

If you want to maximize the amount of money transferred to your beneficiaries, don't give them the limited partnership units outright. Instead, transfer units into an Intentionally Defective Irrevocable Trust (IDIT, also referred to as a defective grantor trust) of which they are the beneficiaries. "That means that as the general partner, you retain responsibility to pay your own tax on your share of the partnership's earnings and the trust's tax on its share of the partnership's earnings too," Mathieu says. "In other words, you pay the gift tax when units are transferred to the trust, and you'll pay the income and capital gains taxes due with respect to the trust. Your beneficiaries will pay nothing unless, or until, they receive a distribution from the trust." Using an IDIT also means that the money used to pay the taxes is not considered an additional gift, so it's not taxed. "Let's say that you donate $1 million in stock to your son in his own name," says Mathieu. "On December thirty-first he comes to you saying he cannot pay the tax, so you pay it for him. There is going to be a gift tax on the money you use to pay his taxes. If instead you give his partnership units to an IDIT trust, this does not occur because you are responsible for that trust's income tax payments."

There's one caveat to the Family Limited Partnership and the LLC: They are more expensive to set up than trusts. "I've seen legal bills as high as $25,000," says Mathieu, "but the amount varies depending on the complexity of the drafting. Some members of the legal profession advise creating one only if you plan to transfer at least $3 to $5 million of assets to the partnership."

How To Give Gifts To Beneficiaries Two Generations Below You

The Traditional Scenario Create one trust for all of your heirs and place in it all of the money you want to give them.
The New Approach Create a separate Generation-Skipping Transfer Tax (GST) trust for beneficiaries two or more generations below you containing $1,030,000 to meet the current GST tax exemption. (The exemption amount increases each year based on the inflation rate.)

The Generation-Skipping Transfer Tax is levied on gifts made to relatives or nonrelatives two or more generations below you (e.g. grandchildren, grandnieces, and grandnephews, great-grandchildren), and is in addition to estate tax and gift taxes due. (For nonrelatives to qualify, they have to be at least 37.5 years younger than you are. Your spouse, regardless of age, is always considered of your own generation.) "Under current law, the GST tax rate is set at the maximum rate of estate and gift taxes, or 55 per- cent," says Mathieu. "However, each person has a $1,030,000 GST tax exemption: You may give away up to $1,030,000 without paying GST tax on it. That's why you should create a trust, put $1,030,000 in it, and allocate your $1,030,000 GST tax exemption to that trust. It does not matter if the trust reaches $100 million. Any distribution from it to a person two or more generations below you is fully exempt from GST tax."

It's important to create a separate trust for the GST tax exemption or you'll end up paying more in GST tax overall. "Let's just say I put $2 million today in a [non-GST-tax-exempt] trust for my sister's grandchildren," Mathieu hypothesizes. "Well, I only have a $1,030,000 exemption. But it is not that the first $1,030,000 passes GST tax-free. The IRS looks at the total value of the gift to determine what percentage the GST tax exemption comprises. In this case, it is approximately 50 percent of the gift. So the IRS multiplies 55 percent, or the GST tax rate, by one-half to get the rate of tax on any distribution. In other words, the GST tax rate is 27 percent. So every time there's a distribution from that trust it doesn't get taxed at 55 percent, it is taxed at 27 percent—but it includes the $1,030,000 that could have been GST-tax-exempt. That's why it's always better to create a trust with just $1,030,000 and to allocate your GST tax exemption to it. If the heirs two or more generations below you need money, the first place they would take it from is this GST-tax-exempt trust."

Another way to circumvent paying the Generation-Skipping Transfer Tax, as well as gift tax: Pay an educational institution or medical service provider directly. "When my sister's children go to college and she needs the money, I'm not going to set a trust up for them," says Mathieu. "Instead I'm just going to pay the educational institution directly on their behalf."

If you are concerned that creating a separate GST-tax-exempt trust for your grandchildren might not leave enough funds for your spouse to live on after you have died, don't worry. You can create a QTIP trust, place $1,030,000 in it, and make a "reverse QTIP election" with respect to the trust. You designate your spouse as the primary beneficiary of the QTIP trust, and heirs two or more generations below you as the remaining beneficiaries. While your spouse is alive, he alone has access to all income (and potentially the principal, if you give him the "right to invade principal") from the QTIP trust. However, upon his death any remaining money in it will pass to the remaining heirs—GST-tax-exempt. And though the QTIP trust is considered part of your spouse's estate for tax purposes, because you made the reverse QTIP election he is not regarded as the transferor of the property when it passes to the heirs—which also means that he in turn can give an additional $1,030,000 GST tax-free to his own heirs.

Good Timing

It's cheaper to give away assets while you're alive and pay the gift tax than to leave assets in your estate and pay the estate tax. Here's why.

Give During Your Lifetime

You are worth $2 million. You give $1 million now to your child and leave the rest to her at your death.

Gift: $1 million
Gift Tax Due: $500,000
Taxable Estate At Death: $500,000 ($1 million ­ gift tax)
Estate Tax Due: $250,000
Amount Of Estate After Tax: $250,000
Total Amount Received By Child: $1,250,000

Bequeath At Death

Your estate is worth $2 million at the time of your death, all of which you leave to your child.

Bequest: $2 million
Gift Tax Due: None
Taxable Estate: $2 million
Estate Tax Due: $1 million
Amount Of Estate After Tax: $1 million
Total Amount Received By Child: $1 million


  • Unified credit for estate and gift tax has already been used.
  • Taxpayer/donor is in 50% bracket for estate/gift tax.
  • Taxpayer lives for three years after gift is made.
  • This is only federal tax. Some states also have their own gift and estate taxes.

Unified Credit

Thanks to the 1997 Tax Act, you can now give up to $675,000—the unified credit—in gifts during your lifetime or at death tax-free. (That's in addition to the $10,000 annual exclusion.) The unified credit is also slated to increase as the graph below shows. However, there is nothing to be gained by waiting: Even if you give the full amount this year, you can still give the difference when the credit goes up. Thus, if you give the full $675,000 in 2000, you can give $25,000 more in 2002.

Delayed Gratification

There's a good reason why it's better to put a smaller gift in a trust now and let it accumulate interest rather than giving a larger sum outright: You incur less gift tax, which can be as high as 55 percent of the value of the gift at the time it is transferred. Here's how the two options stack up.

Give A Larger Amount Outright

Richard holds $100,000 of IBM stock in his portfolio as an investment for his daughter, Amanda.

Richard incurs no gift tax yet.
Richard incurs income tax on interest earned while holding the stock.
Twenty years later, when the value of the stock has grown to $1 million, Richard gives it to Amanda, who in turn sells it.
Richard incurs $500,000 in gift tax.
Amanda pays $180,000 in capital gains tax.
Total Amount Richard Spent On Gift Tax: $500,000.
Total Amount Amanda Spent On Capital Gains Tax: $180,000.
Total Amount Amanda Keeps: $820,000 ($1 million less built-in tax liability).

Give A Smaller Amount In The Form Of A Trust

Richard takes $100,000 of IBM stock and creates a defective grantor trust. He, as the grantor, pays the taxes and names Amanda the beneficiary.

Richard incurs $50,000 in gift tax at the time the money is transferred to the trust.
Richard incurs the trust's income tax liability each year on dividends.
Twenty years later, when the value of the stock has grown to $1 million, the trust sells the shares and distributes to Amanda the entire cash amount.
Richard incurs no additional gift tax.
Richard pays $180,000 in capital gains tax.
Total Amount Richard Spent On Gift Tax: $50,000.
Total Amount Richard Spent On Capital Gains Tax: $180,000.
Total Amount Amanda Keeps: $1 million (includes benefit of income tax being paid by Richard).


  • Unified credit for estate and gift tax has been used.
  • Taxpayer/donor is in 50% bracket for estate/gift tax.
  • Long-term capital gains tax is a flat rate of 20%.
  • Taxpayer lives for three years after gift is made.
  • This is only federal tax. Some states also have their own gift, estate, and capital gains taxes.

A Word of Caution

"More people than ever before are selling estate planning techniques and charitable giving ideas as products," Neuberger Berman's Elizabeth Mathieu says, "and they're selling them on the notion that you can give away a lot of money while keeping a lot, and never give any to the IRS. It's an oversimplification. These aren't products; they're concepts that need to be customized to your own needs. It's impossible to put them in a box and market them."

To QTIP or Not To QTIP?

The QTIP trust, or marital trust, is a good tool for a married person who wants to leave an IRA to a spouse but also wants to make sure that whatever assets are left upon the spouse's death go to children from a prior marriage. Here are three scenarios designed to show how Susan could pass her IRA to her husband James upon her death. Only by using the QTIP trust can Susan be sure that the remaining assets will go to Mark, her son from a first marriage, upon James' death.

Traditional Scenario
Susan creates an IRA in her own name, naming her husband, James, the beneficiary. The IRA grows to $1 million. When Susan dies, her IRA is rolled over into James' IRA.

Susan retains no control over distribution of funds upon James' death.
Susan's estate pays no estate tax on bequest of IRA to James.
James pays income tax on amount withdrawn each year.
James' estate pays estate tax on balance remaining in IRA when James dies.
Mark receives nothing unless James specifies him as a beneficiary.

QTIP Trust Scenario 1
Susan names a QTIP trust as the beneficiary of her $1 million IRA, with James as beneficiary but only with the right to receive the required minimum distribution or all income earned on the fund, whichever is greater. She names Mark the beneficiary of the QTIP trust upon James' death.

Susan's estate pays no estate tax on bequest of IRA to James.
James pays income tax on amount received each year.
James' estate or the QTIP trust pays estate tax on balance remaining in IRA when James dies.
Mark receives the balance of the IRA.

QTIP Trust Scenario 2
Susan names a QTIP trust as the beneficiary of her $1 million IRA, with James as primary beneficiary of the trust. He has the same right to the income as in QTIP trust scenario 1, plus the right to invade principal. She names Mark the beneficiary of the QTIP trust upon James' death.

Susan's estate pays no estate tax on bequest of IRA to James.
James pays income tax on amounts received, whether income or principal.
James' estate or the QTIP trust pays estate tax on balance remaining in IRA when James dies.
Mark receives the balance of the IRA.


  • Unified credit for estate and gift tax has been used.
  • Taxpayer/donor is in 50% bracket for estate/gift tax.
  • Long-term capital gains tax is a flat rate of 20%.
  • This is only federal tax. Some states also have their own gift, estate, and capital gains taxes.

An Artful Approach

Let's say you bought this Picasso, Femme Assise dans un Jardin, at Sotheby's New York auction on November 10, 1999, when it sold for $49,502,500, then gave it to your son or daughter as a gift. You'd have to pay gift tax on the fair market value, which in this case is the purchase price. That would amount to 55 percent of $49,502,500, or $27,226,375.

However, if you gave him or her a 10 percent interest in the painting instead, that would bring down the fair market value of the gift to less than 10 percent of the purchase price, which would also mean a huge reduction in the gift tax. The reason? Because there's virtually no market for a fractional interest in a painting. (For the purpose of this calculation, the price plus the commission was used. In fact, the commission is deducted before the gift tax is calculated.)

Will Power

Most people are quick to rewrite their wills based on changes in family structure—birth, marriage, divorce. And most are tardy to do so when it comes to changes in tax law. "People create wills, put them in a drawer, and don't look at them for twenty years," says Elizabeth Mathieu. "But their estate can suffer because of it. A perfect example is the unified credit law. Some wills created in the past say that $600,000 should go into a family trust because that was the old maximum tax-free amount you were allowed to give. With the new law, that amount is going up to $1 million." Her advice: "If you have a will that was written a long time ago, take it out and make sure that the language is flexible. That way the trustee or executor can generate the maximum tax benefits for the estate and its beneficiaries."

One thing that can actually affect the validity of a will is a change in residency. "A will that was operational and effective under, say, New York law might not be recognized as an effective will, for all purposes, under, say, Florida law," Mathieu says. "The law that applies to your estate is that of the state in which you're a resident when you die."

Let's say that while you were living in New York you drafted a will and named your best friend as the executor. That's perfectly legal. Then let's say you moved to Florida. There, only certain nonresident relatives can serve as the executor of a will, and best friends are not among them.

The key, Mathieu says, is to consider your estate plan a work in progress—in other words, review it on a regular basis and ask an attorney to redraft it to bring it into line with changes in the tax code or other legislation. "An estate plan should not be set in stone," Mathieu says. "It should be flexible to respond to changes in tax laws and in personal circumstance. Gift, estate, capital gains, and income taxes have changed almost every year since they were enacted in the first decades of the 1900s."

The Family Limited Partnership

The Family Limited Partnership, or FLP, is one way to make gifts to heirs during your lifetime and still retain control over the gifted assets. And if you're really feeling generous, you can place their limited partnership units in a defective grantor trust, so that you pay their income tax and capital gains tax, too, without paying any additional gift tax. (Note: Many lawyers advise against creating an FLP unless you have $3 million to $5 million in assets.) Here are three scenarios in which Robert and Melissa, who are married, can give money to Jennifer, their daughter.

Robert And Melissa Pay Gift Tax; Jennifer Pays Income And Capital Gains Taxes

Robert and Melissa give $200,000 outright to their daughter, Jennifer.
The gift is valued at $200,000.
Robert and Melissa pay $100,000 in gift tax.
Jennifer pays income and capital gains taxes on realized appreciation.
Total Amount Robert And Melissa Spent On Gift Tax: $100,000.

Total Amount Transferred To Jennifer: $200,000.

Robert And Melissa Pay Less Gift Tax; Jennifer Pays Income And Capital Gains Taxes

Robert and Melissa create a Family Limited Partnership (FLP) with $1 million. They give Jennifer 20% of the limited partnership, the underlying assets of which are $200,000.

Jennifer's FLP interest is valued at $140,000, a 30% discount to its fair-market value.
Robert and Melissa pay $70,000 in gift tax.
Jennifer pays income and capital gains taxes.
Total Amount Robert And Melissa Spent On Gift Tax: $70,000.
Total Amount Transferred To Jennifer: $200,000 of the underlying value, represented by limited partnership units.

Robert And Melissa Pay Less Gift Tax, As Well As Income And Capital Gains Taxes; Jennifer Receives Full Value Of Gift

Robert and Melissa create a Family Limited Partnership (FLP) with $1 million. They give 20% of the FLP, the underlying assets of which are $200,000, to a defective grantor trust, for Jennifer's benefit.

The trust's FLP interest is valued at $140,000, a 30% discount to its fair market value.
Robert and Melissa pay $70,000 in gift tax.
Robert and Melissa pay income and capital gains taxes on trust's interest for Jennifer's benefit.
Total Amount Robert And Melissa Spent On Gift Tax: $70,000.
Total Amount Transferred To Trust: $200,000 of underlying value, represented by limited partnership units (plus income tax and capital gains tax on asset).


  • Unified credit for estate and gift tax has been used.
  • Taxpayer/donor is in 50% bracket for estate/gift tax.
  • Taxpayer lives for three years after gift is made.
  • This is only federal tax. Some states also have their own gift, estate, and capital gains taxes.
  • Discounts will vary based on facts and circumstances of each transfer.

Charity Case

The one exception to the new golden rule of giving away assets while you're alive is when you want to donate the money in your IRA to a charity. Here it's better to do so at your death through your beneficiary designation. "If you donate the IRA to charity during your lifetime," says Mathieu, "you have to take a distribution yourself, pay the tax, and then give the money that's been taxed to charity. If you wait until you die, the charity will not have to pay the tax because charities are tax-exempt."

Prudent Investor Act

There's been one major change in the law regarding trusts that everyone who has set one up should be aware of. The Prudent Investor Act, which has been passed in some 35 states to date, requires trustees to manage trusts "with the realities of the market in mind."

"From the 1940s to the mid-1990s, most states had the Prudent Man Rule," says Mathieu. "It required that when trustees managed a portfolio in a trust, they had to look at each individual security. But the courts got to the point where they had a preoccupation with speculation. If one security's price fell in a portfolio, the court would hold the trustee liable for it. As a result, many trustees worried so much about liability they put a lot of money in bonds, even if it wasn't the best thing for the trust's beneficiaries." The Prudent Investor Rule prevents trustees from doing so. "It puts a duty on a trustee to think about diversification, after-tax issues, risk, and cost," Mathieu says. "Every state will probably pass some version of it."


Neuberger Berman Trust Company
605 Third Avenue,
New York, NY 10158-3698;
FAX 212-476-9109;