How to minimize estate tax while protecting assets

Key Points

Q: I am working on my estate plan, but also want to protect my assets from lawsuits while I am alive. Is it possible to minimize estate taxation and also protect assets today and in the future?

Gifts of property to family members have long been used in asset protection or estate plans. An outright gift to a spouse or family member not engaged in a high-risk profession has the advantage of removing the asset from claims of future creditors. In addition, a gift has the estate-planning advantage of removing assets from the transferor's taxable estate. Any gifting program must consider gift tax consequences and maximize use of the exemptions available.

In some states, tenancy by the entirety can apply only to real estate or a primary residence. Other states recognize tenancy by the entirety for real estate and personal property.

In states that recognize tenancy by the entirety for real estate only, a common strategy is to minimize any mortgage in an effort to maximize the equity of the protected asset. There is no gift tax consequence upon creation of a tenancy by the entirety if both spouses are U.S. citizens due to the unlimited marital deduction that allows tax-free transfers between spouses.

Tenancy by the entirety is routinely employed when both spouses are at risk of personal liability as a result of their professions. However, it is important to note the potential temporary nature of tenancy by the entirety. For example, the death of one spouse will immediately expose the property to the creditors of the surviving spouse. In instances where only one spouse is at risk, married individuals may transfer real estate and other assets to the spouse not at risk. Through the creation of a particular type of marital trust, the spouse's estate plan can provide for the residence to pass to a trust that will, in large part, protect the asset from the survivor's creditors.

Besides the form of ownership, additional protection can be available by simply obtaining a mortgage against current home equity. The equity proceeds are then invested in an asset-protected manner, such as in exempt assets like interests in family limited partnerships or limited liability companies. Before deciding to implement this strategy, it is important to balance the cost of the anticipated interest expense against the expected earnings of the investment and the protection provided to the situation.

It is crucial for physicians routinely exposed to professional liability to plan well in advance of a potential claim. Such planning should not only involve a review of individual and family assets but also consideration of techniques that can shield a potential inheritance from creditors.

Q: Are there any tax disadvantages to owning municipal bonds?

A: As with most investments, there are some tax considerations you should address if contemplating the purchase of municipal bonds.

The interest earned on a certain class of municipal bonds, called private activity bonds, is treated as a tax preference item for purposes of the alternative minimum tax (AMT). These investments could effectively increase your overall tax liability. The American Reinvestment and Recovery Act suspends this rule for 2009 and 2010. During these two years, investments in any type of municipal bond, including private activity bonds, are excluded from the AMT calculation.

Another tax disadvantage is that up to one-half of an individual's Social Security benefits is subject to tax if one-half of the benefits plus modified adjusted gross income (MAGI) exceeds certain thresholds. For this purpose, MAGI includes municipal bond income, thus potentially increasing taxation on Social Security benefits.

Joel M. Blau, CFP, is president and Ronald J. Paprocki, JD, CFP, CHBC, is chief executive officer of MEDIQUS Asset Advisors, Inc. in Chicago. They can be reached at 800-883-8555 or blau@mediqus.com
or paprocki@mediqus.com
.