Chart shows which methods are most frequently used to pay estate taxes.
When it comes to estate planning, trusts can be invaluable in reducing future taxes. "As a general rule, anyone with total assets -- including a home or business -- worth more than $1 million should use trusts in his or her estate plan," says Joshua Rubenstein, a partner in the New York City law firm Rosenman & Colin.
Unfortunately, surveys indicate that trusts are seldom used by the owners of growing businesses (see "Missed Estate-Planning Opportunities," No. 08920904, Autust 1992), perhaps because they seem intimidating. In fact, they're relatively simple legal documents that split the ownership rights for any asset into two parts: financial interests and legal control. The goal is usually to reduce future taxes.
Normally, both those rights belong to an asset's owner. But he or she can design a trust so that beneficiary rights (the cash) will go to children or a spouse, while legal rights (such as the ability to control investment decisions) will pass to an official trustee, often an accountant or a lawyer.
While there are many trusts to choose from, Rubenstein recommends these two:
Credit Shelter (or Bypass) Trust. This trust helps ensure that your kids save estate taxes on the maximum amount permitted by law (currently $600,000 for each person's estate, $1.2 million for the estates of a married couple). If either spouse dies first, $600,000 worth of his or her estate passes into a trust, which the surviving spouse can benefit from but doesn't legally own; after the survivor's death, the trust passes on to the children free of estate taxes, as does $600,000 from the other spouse's estate.
Insurance Trust. When you assign ownership of your life-insurance policy to a trust that your heirs can benefit from but will not legally own, the death benefit escapes estate taxes. Here's how: When the insured person dies, that person's insurance trust legally owns the proceeds of his or her insurance policy; since the trust owns it, the IRS can't assess gift taxes. Then the trustee (who controls legal ownership) can distribute income or principal to the heirs (who own "beneficiary" rights), still free of estate taxes. Sounds too good to be true, but it's not. -- Jill Andresky Fraser