We're rapidly approaching year end, a time traditionally devoted to income tax planning. But as changes to tax rates are unlikely until 2011, this year advisors would be wise to focus their attention on year-end estate planning.

It's still not exactly clear what estate tax law will look like next year.

Of course, 2010 was supposed to be the glorious year when estate taxes were temporarily repealed. And as great as that sounded to clients, the proposed subsequent reinstatement of a much harsher estate tax regime in 2011 was a much less attractive idea.

Under the current law, the estate tax is scheduled to be repealed for one year (2010) and then come back in 2011, with an exemption of just $1 million and a maximum tax rate of 55%. Compare that to the current 2009 rates which provide for a $3.5 million exemption and a maximum rate of 45%.

But now it seems pretty certain that Congress is going to make the 2009 exemptions and tax rates permanent. So if you have clients who were taking a wait-and-see approach before making changes to their wills and trusts, now is the time to act.

Getting Started

First, make sure you're aware of the estate tax rates in your client's home state. Most states have enacted their own set of estate tax rules that do not coordinate with the federal estate tax exemption. The modern revocable trust will divide into three shares at death to take advantage of the federal and state tax differences, but old-style trust arrangements only have two shares and may result in unnecessary state estate tax (maximum rate, 16% ). If you haven't done so already, now is the time to move your clients into a sophisticated trust to avoid this pitfall.

Another potential tax trap for married couples is joint property ownership. High-net-worth couples can have a few joint bank accounts but any serious investments or real estate assets should be in their individual revocable trust's name. This eases the post-death transition, assures privacy, and allows the three-trust format—which employs three different trusts to minimize federal and estate taxes upon the second spouse's death—to work. Make sure each spouse has about half the total assets. Ownership by a revocable trust is especially important for vacation homes and out-of-home-state property to avoid the hassle and fees involved with completing probate in another state.

How To Move Your Assets

The three most popular techniques of transferring assets to heirs are: the Family Limited Partnership (FLP); the Grantor Retained Annuity Trust (GRAT), and the Grantor Trust (also known as an Intentionally Defective Grantor Trust).

The FLP is really a family investment club. FLPs pool together family assets (including stocks, bonds, alternate investments and real estate) into one family-owned partnership and then family members are allocated shares or units of the partnership. The advantage of the club is that family members' assets are pooled so that account minimums can be met, manager fees can be minimized and all family members get access to sophisticated investments and management. Another advantage is that the family investment club cannot be reached by creditors or divorcing spouses.

Units in the investment club can also be gifted to family members and take advantage of the annual gift tax exemption. Just make sure you file a partnership tax return showing the transfers of the units to family members.

This gifting works even better when combined with the GRAT or Grantor Trust. In fact, the family investment club provides such a significant benefit that Congress is considering eliminating the discount that is permitted on the units that are transferred to family members.

Another way to transfer assets while minimizing gift tax is through a Grantor Retained Annuity Trust (GRAT). The donor establishes a trust using cash or other assets. Then the donor is required to receive annual payments from the trust (this is known as the grantor retained annuity). The payments are specially engineered to return the donor's original investment plus a minimum investment return (or "hurdle rate" set by the IRS).

The hurdle rate for GRATs created in August 2009 was 3.4%, which means that the donor gets his original investment back plus the first 3.4% of earnings. Any assets left over after making the two payments can be distributed to the donor's children (or trusts for them) with no gift tax. This is a good time to set up a GRAT as the hurdle rate is based on interest rates, so when they're low the donor can draw less income and leave more assets in the trust for the beneficiaries.