Planning your estate is largely a matter of asset protection. To preserve your property and resources for your loved ones, you need to keep them as safe as possible from creditors and from lengthy, unnecessary, and expensive legal processes, such as probate and taxes.
Fortunately, the state of Indiana does not currently levy estate tax, gift tax, or inheritance tax on the estates of those who died after 2012. However, Indiana estates remain vulnerable to taxation in at least three ways:
- Federal gift tax
In order to discourage people from giving away all of their assets before death to avoid taxes, the federal government requires you to report gifts over a certain amount. In 2023, it is $17,000 per individual. If you give more than this to an individual during a single year, it will be subject to gift tax unless it can be counted against your unified tax credit for federal gift and estate tax.
- Federal estate tax
For some time, this has only been a concern of the very wealthy. The unified gift and estate tax credit is currently $12.92 million for 2023, but it is slated to change to $6.4 million in 2026. This will expand the number of taxpayers who need to consider their lifetime estate tax exposure.
- State and federal income taxes
A deceased person’s estate has the same income tax obligations as the deceased did. The estate must file federal and state taxes on behalf of the deceased for the current year and for any prior years, if necessary.
One technique that estate planners frequently use to minimize tax exposure is the irrevocable trust. Although there are many modern varieties of trust, they all have certain elements in common. Every trust is formed when a grantor (or settlor) gives assets to a trustee to hold on behalf of one or more beneficiaries. A trustee has a fiduciary duty to a beneficiary, and they must keep it safe and distribute it according to the terms of the trust, which are set out in the document called the trust instrument.
When a grantor creates a trust and hands the property over to the trustee, that grantor no longer owns the property. Nonetheless, the grantor may be allowed to retain some “incidents of ownership”—that is, economic benefits from the property—by the terms of the trust instrument. For example, if someone places their home in a trust, the trust instrument can specify that they retain the right to reside there.
An irrevocable trust is one that the grantor cannot decide to dissolve; it is permanent. Because the grantor has given up control over the property, the law will generally no longer treat the trust assets as the grantor’s property or as part of the grantor’s estate upon death. This can be extremely helpful for estate and tax planning purposes.
However, revenue agencies understand that the purpose of many irrevocable trusts is to avoid taxation. As such, some trusts may not qualify to be treated as separate from the grantor’s estate, and tax laws are frequently revised and updated to keep up with current practice. As such, trusts must be carefully drafted to remain within the law, and trustees must comply with certain rules regarding distributions.
There are several types of irrevocable trust used to protect assets, including:
- Irrevocable life insurance trusts (ILITs)
An ILIT purchases and pays for a life insurance policy on the grantor. When the grantor dies, the trustee collects the death benefit and subsequently pays it out to the beneficiaries named in the trust instrument.
- Qualified personal residence trusts (QPRs)
A grantor may give their home to a QPR, retaining the right to reside there under the trust instrument. After a set period of time, the trustee can convey title to the real estate to the named beneficiaries, avoiding gift tax liability on the full value of the property.
- Crummey trusts
This trust is structured to avoid gift tax liability, often used to give money to minors or heirs. The beneficiary receives a temporary option to withdraw deposits made into Crummey trusts, which allows the monetary gifts to qualify for the yearly gift tax exemption. But they do not exercise that option, and once it expires, the money continues to accrue in the trust account. The trust instrument will specify when and how the trustee should distribute the money—to a child that comes of age, to a college for their tuition, or in any other way that the grantor may choose. This technique may be used in other types of trust as well.
Internet sites often offer boilerplate trust forms to use at home for estate planning, but it is not wise to use these without consulting an attorney in your own state first. They may not be effective under Indiana law, and that could leave you or your family with an expensive disaster. Trustees must comply with obtuse and sometimes changing legal requirements to protect the trust property.
An experienced trust lawyer can assist you and your loved ones in understanding what to do.
Our Anderson, Indiana, attorneys will be glad to speak with you about your estate planning needs. To schedule a consultation, call Beeman Heifner Benge, P.A., at 765-734-9091.