Module 1: Plan Design for JOHN D. SAMPLE and MARY M. SAMPLE

COMPREHENSIVE
ESTATE TAX PLANNING STRATEGIES

PREPARED FOR
JOHN D. SAMPLE & MARY M. SAMPLE

PRESENTED BY

Neil R. Covert, Attorney at Law
Neil R. Covert, P.A.



TABLE OF CONTENTS

·               INTRODUCTION TO THE FEDERAL ESTATE TAX SYSTEM

·               ASSUMPTIONS

·               ILLUSTRATION 1 - NO PLANNING

·               ILLUSTRATION 2 - USE OF A BYPASS TRUST

·               ILLUSTRATION 3 - QPRT

·               ILLUSTRATION 4 - USE OF ANNUAL GIFTING

·               ILLUSTRATION 5 - USE OF DISCOUNTED GIFTING

·               ILLUSTRATION 6 - LIFE INSURANCE PLANNING

·               ILLUSTRATION 7 - USE OF INSTALLMENT SALE

·               ILLUSTRATION 8 - TESTAMENTARY CHARITY

* This letter is provided for informational purposes only and should not be considered legal, tax, or financial advice.  We are not responsible for any actions taken based on the information provided in this letter.
This illustration was prepared by Neil R. Covert, Attorney at Law, on September 26, 2025, and assumes residential property worth $3,000,000 growing at 3.03% and Business and Investment assets of $30,000,000 growing at 5.98%.
Assumes John lives until 2033 and Mary lives until 2043.

 _______________________________________________________

INTRODUCTION TO THE FEDERAL ESTATE TAX SYSTEM

NOTE: This explanation and attached projections are in rough draft form and have not been tailored to the individual situation of the clients.  They are provided for illustration purposes only, and do not constitute a complete or necessarily accurate depiction of the present or future expected scenarios.  We nevertheless believe that this sample explanation and its accompanying charts may be useful to facilitate understanding the estate tax system and how optional planning scenarios can affect John and Mary's estate tax liability and family.

Under the federal estate tax system, the value of a decedent's assets are determined, to include individually owned real and personal property, the proportionate share of jointly owned property, and the value of the decedent's rights in certain trusts, and any "incidents of ownership" held in life insurance policies on the decedent's life will be included in the total. 

Deductions from the gross estate include funeral and administration expenses, the value of assets passing to qualified charities or a surviving spouse who must be a U.S. citizen to qualify an outright disposition for the marital deduction – but if not a U.S. citizen, then a lifetime income trust called a Qualified Domestic Trust (QDOT) will work. The unlimited marital deduction also applies to a trust that pays all income to a surviving spouse called a QTIP Trust – which can also be a QDOT if the surviving spouse is not a U.S. citizen. 

Every U.S. citizen is entitled to a personal unified estate and gift tax exemption which may be used during life to offset taxable gifts with any exemption remaining at death to offset estate tax liability.  An Estate Tax Form 706 must be filed within 9 months of death if the decedent's total assets exceed the exemption amount, even if the net assets after liabilities are below the exemption amount. 

No estate tax is due if the value of an estate minus allowable deductions is less than the decedent's remaining available estate tax exemption. However, filing Form 706 may still be necessary in order to report deductions or apply an available exemption against a potentially taxable gross estate or to make elections such as applying a deceased spouse's unused exemption (DSUE) or to elect to apply the alternate valuation date (if it results in lower overall valuation) as of six months after the date of death.

Federal Unified Estate and Gift Tax Exemption

 Under current law, the federal unified estate and gift tax exemption is annually indexed for the Chained Consumer Price Index, which is lower than the Consumer Price Index and much lower than the actual rate of inflation.  In 2023 each individual's exemption is $12,920,000 per person. Additionally, a deceased spouse's unused exemption (DSUE) may be added to the surviving spouse's available personal exemption. This "portability" feature is elected on a timely filed Form 706 to entitle the surviving spouse to combine the Deceased Spouse's Unused Exemption (DSUE) with their personal $12,920,000 (net of the survivor's prior taxable gifts, adjusting for future annual inflationary adjustments).

For example, if Spouse A only used $1,000,000 of his or her $12,920,000 exemption either through lifetime taxable transfers or against his or her taxable estate, then surviving Spouse B may use Spouse A's unused $11,920,000 in addition to Spouse B's full $12,920,000 exemption, thereby giving Spouse B the ability to shelter $24,840,000 against future taxable gifts or against Spouse B's future estate at death.  The DSUE that transfers to the surviving spouse does not increase with inflation.

If the first dying spouse's gross assets are less than the estate tax exemption amount then the estate and surviving spouse have up to five years after the date of death of the first dying spouse to file a Form 706 Estate Tax Return that elects for the portability allowance to pass to the surviving spouse.

The Internal Revenue Code has provided relief to estates making late portability elections of DSUEs without requiring any user fee or a private letter ruling. This simplified method permits an extension of time under § 301.9100-3 of the Procedure and Administrative Regulations for the surviving spouse to make a portability election under I.R.C. § 2010(c)(5)(A) up to five years after a proper election should have been made on Form 706 from a deceased spouse's estate.

If a surviving spouse remarries, any properly elected DSUE is not necessarily lost. Rather, a surviving spouse may combine their own personal unused exemption with a properly elected DSUE from their last dying spouse in a new marriage to shelter lifetime taxable gifts or future estate tax liability. However, if the new spouse predeceases them, then the newly deceased spouse's unused exemption is applied.

Lifetime gifts exceeding an annual gift exclusion (currently set at $17,000 per Donee as of 2023, and further explained below) reduce a person's lifetime $12,920,000 exemption on a pro rata basis.

Annual Gifting 

An individual may make certain annual gifts to other non-exempt persons or irrevocable trusts without incurring gift tax.  The annual excludable amount is indexed for inflation, and is presently set at $17,000 per Donee recipient (for 2023).  Spouses may elect (on a Gift Tax Return Form 709) to combine their annual excludable gifts, permitting a couple to make a gift in the amount of $34,000 per Donee recipient.  The individual or couple may make gifts to as many different people or properly drafted trusts as they wish each year, and often desire to follow an annual gifting schedule the same Donee recipients. 

Gifts are commonly made to irrevocable Gifting Trusts also known as "Crummey Power Trusts" where beneficiaries have a temporary right to withdraw, in order to qualify contributions to be treated as if they were transferred to individuals.  The "Crummey Power" is named after a 1968 Ninth Circuit U.S. Court of Appeals case D. Clifford Crummey v. Commissioner of Internal Revenue which established that a beneficiary's right to withdraw contributions to the trust constitutes a gift of a present interest even when the beneficiary waives his or her right.  A "Crummey Notice" should be given to the beneficiary or guardian advising of the right to withdraw contributions for a limited time. Subsequent cases have held that beneficiaries who do not receive notice of contributions may still qualify if there was a legal right to make a withdrawal, especially if the beneficiary had general knowledge from the past that contributions were being made. 

Gifts below the current $17,000 individual or $34,000 joint spousal threshold will not affect the lifetime exemption amount of $12,920,000. Gifts between spouses who are U.S. citizens are always estate and gift tax free, regardless of amount. 

Annual gifting may be combined with various estate planning techniques to minimize allowable transfers that avoid federal estate tax.  Individual or joint gifts of values exceeding the current annual exclusion amount of $17,000 or $34,000 to an individual Donee require reporting on a Gift Tax Return (Form 709), where cumulative taxable gifts are subtracted from the Donor(s)' lifetime exemption amount available. 

In other words, each individual is currently entitled to a maximum $12,920,000 exemption from gift or estate taxes. In each year that an individual makes taxable gifts exceeding the current $17,000 per Donee excludable amount, the excess value of those gifts are subtracted from the beginning balance of $12,920,000 on Form 709 which is filed with the IRS. Whatever balance remains unused at death becomes the amount available to shelter an individual's federal estate tax liability. 

There are several ways to strategically utilize the first dying spouse's exemption to maximize the estate tax shield applied to the surviving spouse's estate. The illustrations produced by this software demonstrate how certain estate planning techniques may impact an estate plan and a family's legacy. 

NOTE:  If Congress does not extend the current estate exemption legislation by 2026, then a living person's unused exemption will be proportionately reduced (based on the new lower lifetime exemption, minus any amounts previously utilized), but not less than zero. In other words, there will be no Congressional "claw back" for an individual's use of previous allowable exemption amounts that exceed a new lower threshold.
________________________________

Illustrations in this program can show the impact of various strategies under the assumption that the current exemption of $12,920,000 will continue to be indexed for inflation AND whether the exemption will be reduced by approximately one half of what they would have otherwise been in 2026, when the current estate legislation is scheduled to "sunset." 

In the event that one spouse dies before 2025 and leaves a portability allowance, then any such portability allowance will not be reduced if the surviving spouse later qualifies to use it. 

This illustration also assumes that the surviving spouse will be able to use any portability allowance that may be passed by the first dying spouse, and therefore assumes that the surviving spouse will not remarry someone who dies before him or her.

 _________________________________

ASSUMPTIONS

ILLUSTRATION 1 - NO PLANNING

This first illustration assumes no annual gifting, and no life insurance trusts.

The first row shows Bob and Mary's assets in 2023.

The second row illustrates the assumption that Bob's death occurs first and reflects the increase in asset values as of the date of the first death. Mary received the life insurance proceeds on Bob's life policy. This row shows all assets transferred to the surviving spouse to defer potential federal estate tax until the second death.

Many couples will allow this to occur, utilizing the deceased spouse's unused exemption (DSUE).

In this illustration the surviving spouse will be eligible to utilize a total exemption of $22,670,000 ($9,290,000 from Bob's projected DSUE + $13,380,000 from Mary's projected available exemption).

The third row illustrates Mary's projected estate values at their death in 20 years leaving $75,160,335 worth of personal assets exposed to federal estate tax. Life insurance is also exposed to federal estate tax at the second death in this scenario.

Applying Bob's DSUE of $9,290,000 leaves Mary's net estate of $52,490,335 subject to federal estate tax. Assuming a 40.00% estate tax rate, the estate tax would be $20,996,134 and is normally owed 9 months after the surviving spouse's date of death.

For estates substantially comprised of large closely held businesses, an executer may be entitled to make an election under I.R.C. § 6166 to defer the payment of estate taxes up to five years with interest-only payments, thereafter making equal payments over the following ten years. Such an election alleviates an estate's illiquidity and may avoid the need to sell assets at a disadvantageous time triggering a loss.

ILLUSTRATION 2 - BYPASS TRUST

An irrevocable Bypass Trust, also known as a "Family Trust" or "Credit Shelter Trust" may provide lifetime income to a surviving spouse while shielding the trust assets from federal estate tax at the death of the surviving spouse. The Bypass Trust may also allow principal distributions for the surviving spouse's health, education, maintenance, and support (known as the HEMS standard). The Bypass Trust may be funded according to provisions in the Decedent's Will or by a procedure whereby the surviving spouse disclaims certain assets which then pass into the Bypass Trust for the beneficiaries' remainder interest.

The amount of assets used to fund the Bypass Trust often utilize the Decedent's maximum available estate exemption, with the excess amount funding a Marital Trust over which the surviving spouse would have full discretion, and thus will be includable in the surviving spouse's estate.

Assets remaining in the Bypass Trust upon the second spouse's death may be allocated to a separate Generation Skipping Trust (GST) to benefit individuals who are more than one generation younger than the original Grantor (including a grandchild or any other individual at least 37.5 years younger than the Grantor). However, without proper planning, transfers to a "skip generation" beneficiary could trigger a stacked 40% GST tax on top of any estate taxes. Your experience estate planning professional will be able to discuss further options for utilizing the separate GST exemption in addition to any available estate tax exemption ported between spouses.

In this illustration, the Bypass Trust is funded in the amount of $9,290,000 upon the first death. The deceased spouse's estate tax exemption is used to the extent of $9,290,000 by funding of the Bypass Trust shown in the second column, at Bob's death in 2033

Under this scenario, the Bypass Trust grows to $13,206,106 based upon the assumed 3.58% rate of return, and will not be subject to federal estate tax at the second death.

Applying a 40.00% estate tax rate, funding the Bypass Trust saves $1,566,442 in federal estate tax.

Because Bob Sample had $9,290,000 in exemption when he died, and only $9,290,000 went to the Bypass Trust, the portability allowance that can pass to Mary Sample was $0 and will be usable by her unless she remarries someone who dies before her, in which event that next dying spouse's portability, if available, would apply.

ILLUSTRATION 3 - QPRT

This illustration shows estate tax savings from using one or more Qualified Personal Residence Trusts.

A Qualified Personal Residence Trust (QPRT) is an irrevocable trust created when the owner of a primary residence and/or vacation home makes a gift transferring the property's title to the trust. Thus, the value of the home and its future appreciation is removed from the owner's estate, while the owner retains the right to reside in the home for a term of years. Since the transfer does not represent a gift of a present interest, the value of the property cannot be reduced by the annual exclusion ($17,000 in 2023).

The QPRT represents an IRS-sanctioned exception to the general rule that Grantors are prohibited from the use or enjoyment of property that qualifies as a gift. To comply with IRS rules, the trust term is set to a specific period of time that is expected to be shorter than the owner's life expectancy. At the end of the term, title passes to the trust beneficiaries, and the owner begins paying fair market rent to them if the owner desires to continue residing in the home. These rental payments do not constitute taxable gifts.

This technique freezes the value of the home when it is transferred into the trust, and the gift is discounted according to actuarial assumptions applied to the remainder interest transferred to beneficiaries using IRS mortality tables and the Sec. 7520 rate in effect. The higher the 7520 rate, the lower the gift value, and thus the higher the potential estate tax savings.

ILLUSTRATION 4 - ANNUAL GIFTING

This illustration shows the use of annual gifting.

Under current law (2023) individuals do not need to report gifts up to $17,000 per year, per Donee, or joint gifts up to $34,000 per year, per Donee made by married spouses. There is no limit on the number of Donee recipients in a single year.

Gifts may be given directly to recipients or through the use of a Gifting Trust, whereby a Trustee controls the investments and distributions to beneficiaries. A Gifting Trust may protect beneficiaries from claims of their creditors, divorcing spouses, or simply from making inappropriate financial decisions with their cash gifts.

This example shows Bob and Mary jointly making non-reportable gifts of $17,000 each per child, or grandchild, totaling $34,000 per year. This illustration reflects projected increases in annual gifts with CPI inflationary adjustments, totaling $3,971,205 in 20 years.

Applying a 40% estate tax rate, the combined savings from the annual gifting for both Bob and Mary is $1,588,482.

ILLUSTRATION 5 - DISCOUNTED GIFTING

Valuation discounts may apply when certain ownership interests are transferred, such as interests in family limited partnerships (FLPs) or limited liability companies (FLLCs) holding businesses or investments. There are advantages to gifting partial ownership interests in lieu of cash. When less than 50% business interests are gifted, the asset may be entitled to a valuation discount due to minority interests lacking management control and lacking outside marketability of a partial interest in a closely-held family business.

The amount of the discount entails a subjective case-by-case determination; however, a 30% discount is often justified. Valuation discounts provide an opportunity to transfer more assets (and the future appreciation) out of the Donor's estate.

For example, if Bob and Mary transferred $1,000,000 worth of assets into an FLP or FLLC and then made a gift of a 10% minority interest or non-voting interest from the entity, this nominal transfer of $100,000 out of their estate might only utilize the discounted amount of $75,000 of their lifetime exemption, assuming a 25% valuation discount.

This example shows Bob and Mary jointly making non-reportable gifts of $17,000 each per child, or grandchild, totaling $68,000 per year. Applying a 25% discount to their gifts and projected increases in annual gifts adjusted for inflation removed a total of $5,294,940 from their taxable estates.

The estate tax savings from the discount feature, based upon gifting $68,000 per year during Bob and Mary's lifetime, and later gifting $34,000 per year of gifting during Mary's survivorship, is $529,494.

ILLUSTRATION 6 - LIFE INSURANCE

This illustration shows estate tax savings from using one or more Life Insurance Trusts.

Life insurance can be an essential tool in estate planning. The proceeds of a life insurance policy can be used to pay estate taxes, debts, and other expenses, as well as to provide support for surviving family members. Life insurance can also provide estate liquidity, permitting heirs to receive their inheritances sooner rather than waiting for assets to be sold.

When purchasing a life insurance policy for estate planning purposes, it is important to consider the ownership and beneficiary designations on the policy. If the policy is owned by the insured, the proceeds will be included in the insured's taxable estate. Instead, if the policy is owned by an Irrevocable Life Insurance Trust (ILIT), the proceeds are not included in the insured's estate, and may provide additional benefits of creditor protection and allow the trustee's control regarding distributions of the proceeds.

A caveat to remember is that the ILIT must have purchased the policy to be assured of its exclusion from the insured's estate or if an existing policy is transferred to an ILIT the insured person must survive such transfer by at least three years in order to exclude the proceeds from the insured's estate. However, there are exceptions to that rule if the policy was sold to the ILIT for adequate consideration.

When the insured person transfers cash or other assets to the ILIT to pay the annual policy premiums the transfer constitutes a "gift" and a specific procedure must be followed involving sending "Crummey Notices" to the policy's beneficiaries to maintain exclusion from the taxable estate. This procedure is based on the 1968 federal case Crummey v. Commissioner, whereby beneficiaries are notified (via Crummey Notices) of their right to withdraw cash gifted to the trust for covering premium payments. The specific procedures permit the premium payments to be deemed a gift of a present interest.

In this scenario, the total savings from Irrevocable Life Insurance Trust planning is $246,264.

ILLUSTRATION 7 - YEAR 1 GIFT / INSTALLMENT SALE

One of the most effective tools available to reduce Estate Tax exposure is the Installment Sale to an irrevocable trust.

An "Irrevocable Sale Trust" is established to purchase assets from Bob and Mary in exchange for an installment note. The Trust is thereby excluded from their estate and the sale does not utilize any lifetime gift exemption since it is structured as a sale rather than a gift. Bob and Mary may choose to continue to pay income taxes attributable to the trust's taxable activity to further reduce their estate assets without their payment utilizing any of their lifetime Gift Tax exemption. However, Bob and Mary may toggle the income tax inclusion at any time so that the trust begins paying its income taxes at the trust level.

This illustration assumes that Bob and Mary will always pay the income taxes on the trust.

This illustration shows Bob and Mary making a $1,500,000 seed capital gift to the trust, and shortly thereafter selling an ownership interest in an LLC or Family Limited Partnership in exchange for a Promissory Note.

The business interest worth $15,000,000 is discounted by 30.00% resulting in a sale of $10,500,000 asset.

We are showing that you would make a $1,500,000 seed capital gift to the trust, and shortly thereafter sell an ownership interest in an LLC or Family Limited Partnership in exchange for a Promissory Note.

In exchange for the transfer Bob and Mary receive a 4.00% note for the $10,500,000 sales price. The note is structured to pay interest only with a balloon payment of the principal due in 20 years. Before or at its maturity the note may be refinanced, or potentially converted to a Self-Canceling Installment Note ("SCIN").

This illustration shows the sale occurring in 2023 and growth of assets through the 2nd death in 2043. At that time, the Irrevocable Sale Trust will hold $30,641,636 of assets that can pass outside of the estate into trusts providing lifetime benefits to children or other beneficiaries without triggering estate tax upon their deaths.

The estate tax savings from this installment sale of discounted assets would be $11,649,994 based upon the assumptions set forth herein.

ILLUSTRATION 8 - TESTAMENTARY CHARITY

The next illustration shows that allowing a residuary estate to pass to a Charity, a Family Charitable Foundation, or Charitable Lead Annuity Trust (CLAT) will always result in zero estate taxes, but will reduce the total amount passing to non-charitable Beneficiaries.

Here we show Bob Sample and Mary Sample's residuary estate of $14,154,303 that would otherwise be subject to 40% estate tax passing to a Charity, resulting in $0 Estate Tax.

Whether passing the residuary estate directly to charities, or by utilizing a CLAT, estate taxes will be zeroed-out. However, the advantage of utilizing a CLAT is that the assets continue to grow during the charitable payment term, resulting in potentially more remainder assets passing to family Beneficiaries after the end of the charitable payment term.

For example, if Bob Sample and Mary Sample's net taxable estate passed directly to one or more qualified Charities, the amount passing to non-charitable Beneficiaries would be $61,006,032.

However, passing the $14,154,303 residuary estate to a CLAT allows more time for the assets to grow tax-free while making annual payments to one or more charities.

To effectuate a testamentary CLAT Bob Sample and Mary Sample's Will and Trust documents would contain specific provisions directing the Personal Representative or Trustee to allocate the maximum assets that would offset the finally determined estate tax liability.