For today's business owner, death can mark the beginning of a significant tax problem. The investment and sweat that went into building your business year after year could add up to a whopping federal estate tax bill for your heirs -- up to 45% of the combined value of your company and other assets.

With careful planning however, there are still ways to reduce the tax burden on your loved ones, while keeping the business intact. The following gives an overview of some available estate planning options.

Marital Deduction. One common estate tax reduction strategy is the "marital
deduction." This allows you to leave an unlimited amount of assets to your surviving spouse tax-free for federal estate tax purposes. Marital deduction bequests may be outright or in trust. A trust may be needed if significant assets are involved and professional management and administration are desired. Also, a trust may afford protection against the demands of relatives and creditors. This deduction must be used carefully; however, as using it to the fullest extent possible may adversely affect the surviving spouse's estate tax situation. Note also, if you and your spouse are non-U.S. citizens, special requirements must be satisfied for the marital deduction to apply.

The Estate Tax. With proper use of the marital deduction, no estate taxes need be owed upon the death of the first spouse. But there's a limit on what can be passed tax-free to other heirs, either as gifts during your lifetime or from your estate. In 2007, the gift and/or estate tax credit allows each spouse to exclude up to $2 million in value from a taxable transfer. This amount, known as the applicable exclusion amount may be large enough for you to pass on your entire business free of federal estate taxes. But after both you and your spouse die, estate taxes will be due if the surviving spouse’s estate is worth more than the exemption equivalent. Estate taxes start at a hefty 37% on the first dollar above the applicable exclusion amount and increase to 45% while estate taxes are scheduled to be eliminated in 2010, the next year the tax rates return to 55% with an exemption of $1 million.

Sizing Up Your Estate. At first blush, the amount which is exempt from estate taxes – currently $2 million -- may sound like a huge sum. Many business owners mistakenly assume they have less than that and figure no special tax planning is needed. Unfortunately, they tend to undervalue their assets or fail to take all of them into account. You may have accumulated several hundred thousand dollars of equity in your home.

The value of your company, rental properties, your pension plan and other savings are also part of your estate, as is your life insurance policy if you own the policy or have incidents of ownership in the policy (such as retaining the power to change the beneficiary) at your death. Even if you don't consider yourself wealthy, it's easy to see that $2 million-plus in assets is quickly accumulated. If you and your spouse had combined assets of less than $2 million when your will was first written, but now exceed that amount, it's likely you'll need some estate planning.

Credit Shelter Trust. Used correctly, credit-shelter trusts can double the amount you and your spouse leave to your children free of federal estate taxes. Here is an example based on the $2 million exemption amount allowed in 2007. Suppose you leave your entire $4 million estate outright to your spouse. After your death, your estate incurs no federal estate taxes because of the unlimited marital deduction. But upon the death of your spouse in 2007, only half the estate ($2 million) is exempt. Your children will pay federal estate tax, NJ state taxes & administrative costs on 2,000,000, totaling approximately 1,300,000 in taxes (estate shrinkage of 35%, that's poor planning).

Instead, suppose you willed only $2 million to your spouse outright, and put the other $2 million in a credit-shelter trust. Your spouse would be entitled to income from the trust after your death. But after the death of your spouse, the assets in the trust won't be part of your spouse's estate, so they'll also pass tax-free to your children. And the other $2 million is also untaxed due to your spouse's own $2 million exemption. Assuming no appreciation or depreciation of the asset values, your children inherit $4 million free of estate tax.

To ensure that your children will enjoy these savings, your spouse should have a credit shelter trust in his or her estate plan. Also, each spouse should have assets valued at the applicable exclusion amount in his or her own separate name to leave to those trusts.

A word of caution: to enlarge the advantages provided by the 2001 tax law, a review of your will, trusts and any other estate planning documents is in order. As the new exemption limits go into effect, wills that mention a $600,000 or $1 million figure, for example, may need to be rewritten, and individuals who have carefully divided their assets so that each spouse has at least $2 million in assets may have to adjust their holdings. The increase in the exemption amounts means that, with proper planning, married couples who can exempt $4 million of assets today, could exempt $7 million as of 2009.

Transferring Gifts. Another way to reduce estate taxes is by making lifetime gifts. You can reduce the size of your estate by giving $12,000 worth of assets each year to as many people as you want, without eating into the $2 million exemption. A husband and wife can transfer $24,000 this way every year -- $12,000 per parent -- to each recipient. The tax law adjusts the $12,000 annual exclusion for inflation every year.

Once you make such a gift of cash or other assets, any future appreciation is also removed from your estate and escapes federal estate taxes. That's why you may want to consider giving assets away that are expected to increase in value between now and your death. It may mean a bigger tax savings.

Life Insurance Trust. Life insurance proceeds become part of your estate and are subject to estate taxes if you own the policy or have incidents of ownership in the policy at your death. But by setting up an irrevocable trust and making it the original owner and beneficiary of your insurance policy while you're still alive, the proceeds may be kept out of your estate – which means tax savings.

After the trust is established, you can make yearly payments to the trustee who, in turn, can pay the premiums. The proceeds of the policy may be held in trust and made available to provide income to your spouse and children, or anyone else whom you designate in the trust document. The cash in the trust may be used to pay estate costs on a very tax-efficient basis. Entrepreneurs tend to be do-it-yourselfers. But estate planning is an area where the solo approach could be risky. There are many ways to run afoul of the rules. In planning your estate, seek the advice of an experienced financial planner who is knowledgeable about closely held businesses.

Saul M. Simon CFP® located in Edison NJ specializes in working with individuals and businesses to develop strategic financial plans that help them reach the goals they have set. Visit my website at www.saulsimon.com. I can be reached at
888-SIMONSAYS. (1-888-746-6672 or by E-mail: simonsays@LFG.com).