Based upon the foregoing, each taxpayer now has the ability to transfer up to $5.25 million free from the federal estate and gift tax. A married couple can therefore transfer $10.5 million free from the federal estate and gift taxes. Any transfers in excess of this amount will be taxed at a flat 40 percent for federal purposes. Pennsylvania also imposes an inheritance tax that is 0 percent on transfers to a spouse, 4.5 percent on transfers to lineal ascendants and descendants (e.g., parents, grandparents, children, grandchildren), 12 percent to siblings and 15 percent to anyone else (except charity, of course).
With the increase in the federal estate tax credits, not all royalty owners will need sophisticated federal estate tax planning. For most, the potential cost of entering a nursing home is a much greater concern. In other words, the individual who owns 20 or 50 or 100 acres could certainly receive a substantial sum of money for leasing his or her property and not have to worry about a 40 percent inheritance tax. Owners of larger tracts may still find it necessary to explore more sophisticated options.
For those who do need some more sophisticated options, a variety of vehicles should be reviewed. Both Pennsylvania and federal law provide that there is no tax upon the death of the first spouse if the surviving spouse receives all of the property (either outright or in certain trusts). Tax will not be due until the death of the surviving spouse. One way to maximize savings and reduce taxes owed is to create a Credit Shelter Trust upon the death of the first spouse. A CST enables the first to die to leave part of his or her estate to his or her spouse in a trust for life with a remainder to his or her children. The CST can be funded with an amount up to the federal estate tax credit amount (currently $5.25 million), will provide income and financial support to the surviving spouse for life and then pass to heirs free from federal estate tax.
The first to die can then leave the remainder of his or her estate to the survivor either outright or in trust. A "QTIP" trust is a viable choice, as it provides financial support to the survivor but protects the trust assets in the event of a second marriage or if the surviving spouse becomes incapacitated.
A dynasty trust is another viable option. If properly constructed and funded, dynasty trusts can put the assets in the trust beyond the reach of estate taxes (and creditors and divorces) for the life of the trust which can be perpetual. Dynasty trusts can be established by the landowners while they are alive or at death and, if drafted properly, are not subject to realty transfer taxes when land or subsurface rights are transferred into them.
Other types of trusts that can be considered are charitable remainder trusts, where the grantor gets income from the trust for life and the remainder goes to the charity, and charitable lead trusts, where the charity receives income during the grantor's lifetime and the remainder is passed to heirs.
The LP or FLP is another very popular strategy when planning for bonus and royalty payments. The FLP is established with a general partner and one or more limited partners. The general partner controls the FLP and is typically owned by the landowner. The limited partnership interests can be given to the landowner's children, grandchildren, etc., and can be given outright or in trusts (even dynasty trusts).
The FLP is flexible, as it allows the landowner to give away less than all of the limited partnership interests so the landowner can still enjoy some of the bonus and royalty payments, yet share them with family members as well.
One word of caution about the use of the FLP. Transfers of land or subsurface rights to an FLP are subject to realty transfer taxes based upon the value of the interest transferred even if it is a gift. The realty transfer tax is generally 2 percent of the value of the interest transferred. Therefore, the transfer of land or subsurface rights with a value of $1 million would trigger a $20,000 tax payment. Unfortunately, landowners are not always advised that the transfer tax is due and owing.
Sometimes an FLP makes sense, but other times, a CST, QTIP or dynasty trust is more advantageous. And for some, nursing home costs are a much larger concern than all the tax aspects. Only one thing is sure: The earlier in the process planning begins, the better. Choose an adviser that knows this area so you can avoid pitfalls.
R. Douglas DeNardo is a shareholder at Rothman Gordon, chairman of the estates, trusts and taxation department and is a member of the firm's executive committee. He represents individuals, professionals and owners of closely held businesses and professional corporations and associations, working with them to develop strategies to meet their wealth transfer goals. He also counsels professionals and business owners on comprehensive asset protection planning strategies, including domestic asset protection trusts.