Once upon a time, if you had a net worth over US$1 million, you gained entrance to a very exclusive club.
It’s not so exclusive today: According to the World Wealth Report 2008, at the end of 2007, there were about 3 million millionaires in the United States, or approximately 2% of the adult population. That really shouldn’t come as a surprise, especially if you live in a state like California, where even a modest home can have a value approaching US$1 million.
Even if inflation has made entrance into the Millionaire’s Club less selective than it once was, if you qualify, you also may also be eligible for something else considerably less desirable: the U.S. estate tax.
Absent congressional action, on Jan. 1, 2011, the U.S. estate tax exclusion reverts to its 2002 level—US$1 million. If you're a U.S. citizen or permanent resident, the balance of your estate will be subject to estate tax at a maximum rate of 55%. Everything you own is included, anywhere in the world, valued at its "highest and best use." Your heirs may also have to pay estate tax in the state where you lived.
Why You Might Consider Dying in 2010
Between now and 2011, courtesy of Congress, the estate tax pulls a disappearing act—but only for one year.
For 2008, you have an estate tax exclusion of US$2 million and a top rate of 45%. In 2009, the exemption increases to US$3.5 million. And, it disappears completely in 2010.
But alas, only for one year. Unless Congress takes remedial action, the estate tax resurfaces in 2011 with US$1 million exclusion and a top rate of 55%.
Disinherit the IRS from Your Estate Plan!
While it would be wonderful if Congress eliminates the uncertainty surrounding estate tax after 2011, I wouldn’t count on it doing so. The easiest course of action for Congress would be to do nothing. And that may be exactly what Congress will do, especially given the prospect of a US$700 billion Wall Street bailout and annual budget deficits approaching US$1 trillion/year. Not to mention that official government budget projections assume that the estate tax will return to 2002 levels in 2011.
Fortunately, many tools are available to reduce estate tax. Indeed, if you make advance preparations, estate tax is truly a voluntary tax. Moreover, if you’re seeking enhanced protection for your wealth against legal predators, are concerned about the drooping value of the dollar, or simply want to take advantage of international investment opportunities, you can construct your estate plan offshore.
Three Top Offshore Estate Planning Opportunities
Several offshore estate-planning techniques exist that you and your professional advisors may wish to consider. They include:
Offshore limited liability companies. One of the most popular estate planning techniques involves partnerships: e.g., limited partnerships (LPs) and limited liability companies (LLCs). Let’s say you form a LLC in Nevis (one of the most popular offshore jurisdictions for this purpose) and contribute the bulk of your estate to it; say, US$3 million. You then begin making periodic gifts of “membership interest” in the LLC to your children.
At your death, your interest in the LLC is only worth US$2 million. Your heirs file an estate tax return that shows a membership interest in a LLC worth $2 million. However, with proper planning, they can claim a “valuation discount” on this interest for estate tax purposes. Generally, a 25% discount is considered very conservative. That means this simple structure could reduce the size of your taxable estate by at least US$500,000, resulting in a whopping US$225,000 savings in estate tax at today's rates! And, thanks to the stringent asset protection provisions of Nevis law, the funds within the LLC will be very well protected from lawsuits.
Offshore trusts incorporating a “marital bypass” provision. If you’re married, a simple trust called a marital bypass trust (sometimes referred to as an “A-B trust”) can double your estate tax exemption. While this kind of trust often stands alone, you can also incorporate it into an offshore trust formed in any suitable offshore jurisdiction. (Nevis and the Cook Islands are two of the most popular choices.) That way, you’ll obtain state-of-the-art asset protection for your wealth, and also double your estate tax threshold.
Offshore variable universal life insurance. Life insurance enjoys uniquely preferential tax treatment under U.S. law. With proper structuring, the proceeds can flow to beneficiaries free of both estate and generation-skipping taxes. Essentially, you avoid tax on portfolio income and transactions in exchange for the cost of insurance.
The most flexible life insurance policies are variable universal life insurance (VUL) policies. With this type of policy, the insurance carrier establishes a portfolio of securities or other assets owned by the policy. The value of the policy is determined by the performance of investments within that portfolio.
Offshore VUL policies have numerous advantages over domestic policies. The most significant advantages are greater asset protection and tax-deferred access to foreign securities markets.
The bottom line: If you’re a member of the “Millionaire’s Club”—or may become one in the future—you need to consider estate tax in your wealth preservation plan. And while a strictly domestic estate plan may suit your needs, if you’re looking for enhanced asset protection and greater investment choice, numerous offshore estate-planning options are available.
One final note: Proper structuring of your estate plan requires substantial legal expertise. There are many potential pitfalls. Be certain to retain a qualified attorney before you put any of these strategies into place.
Copyright © 2008 by Mark Nestmann
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