How to manage your estate while you’re still alive
(First of two parts)
My father was one of those old-school gentlemen who used to tell his children, “I’m not leaving you anything but your education.”
The intention was, of course, to make sure that we wouldn’t simply coast along, overconfident that we would have cash-stuffed pillows with which to cushion our behinds when, inevitably, we slip on the banana peels of life.
Well, as it so happened, he did leave us a more material inheritance than our education. Having been brainwashed to believe that we were only entitled to what we earned by the sweat of our brow, we were duly grateful for the largesse.
We were, however, a bit disconcerted by the estate taxes we had to pay, but hey, we didn’t put in a single minute’s effort to earn that inheritance, so with a few sighs, we settled the estate and paid the taxes.
Not all Filipino parents, though, are as rigorous as my dad. Most want to spare their children the burden of estate taxes, which come on top of the other expenses tied to moving from this life into the next—doctor’s fees, hospital bills, wake-cum-all-day buffet, interment and, finally, the 40th-day anniversary-cum-banquet.
One of the most common methods of avoiding, or at least reducing, estate taxes is to incorporate, i.e., transfer assets to a corporation in exchange for shares. This can be a tax-free transaction if you can get a ruling from the Bureau of Internal Revenue (BIR) that it qualifies as such, and a BIR ruling takes time.
However, once the shares are transferred to the children while the patriarch (or matriarch, as the case may be) is alive, the transaction is considered a donation, or gift, and subjected to a donor’s tax.
A caveat, however. This method works best if the intention is to continue the family’s business as a going concern, with spheres of operation for each heir clearly defined.
If, on the other hand, the intention is merely to avoid the tax bite on the estate, you had better be sure that the heirs are the epitome of sibling harmony, who are and will remain stone-deaf to the grumblings of spouses and children that they are getting the short end of the stick.
Incorporation is no guarantee that sibling wars will not erupt later on, and bystanders who are merely bored by Kris Aquino’s tawdry, teary tales of marital mishaps will gasp in delighted horror at accounts of de buena familia scions hurling themselves on the hood of the car bearing away the enfeebled patriarch from yet another intra-corporate/family squabble.
Besides, corporations will still have to pay a corporate income tax return of 35 percent, plus business licenses, permits, etc. There are also reportorial requirements that have to be complied with; at the very least, submission of an annual report to the Securities and Exchange Commission.
Of course, shareholders can conveniently forget to pay the taxes, or cook the books, or allow the company to go dormant, but with increasing computerization of government records and cross-checking of TINs, the day of reckoning draws ever closer. Beware the gleeful ferocity of the BIR agent who manages to track you down.
Plus, even with incorporation you don’t escape estate taxes entirely. Once a shareholder—say, the patriarch—dies, his shareholdings are liquidated, and estate taxes levied on them.
The legitime or after-tax proceeds of the estate which are reserved by law for the compulsory heirs—spouses, children (whether legitimate, illegitimate or adopted) and parents—may or may not go to the other shareholders.
Considering the permutations of living arrangements nowadays, the patriarch’s legitimate children who are co-shareholders may find themselves in for a surprise. The free portion of the estate also may or may not go to the co-shareholders, depending on the deceased shareholder’s will. In which case, for the legitimate children, it’s goodbye, asset, it was nice knowing you while you were still within the family fold.
Incorporation, however, is not the only method of reducing the estate tax for the next generation. Another method is to set up an irrevocable living trust. It’s called a living trust for the simple reason that it is set up by the trustor (also known as a grantor) for the benefit of a beneficiary or set of beneficiaries while he is still alive.
Banks also have a bank product called a living trust agreement, which can be confusing. For purposes of this article, I will refer to a non-bank trust as an expanded trust, and the bank product as a bank trust.
Assets placed in an irrevocable trust, whether an expanded trust or a bank trust, are classified as donations, and subjected to donor’s tax. Since these assets are sliced off, permanently, from the estate, they will not be subjected to the estate tax. Both the donor’s tax and the estate tax have graduated schedules, but the rates for donor’s tax are lower than for the estate tax.
You can refer to tables on the donor’s tax and estate tax found on the BIR website if you want to compute how much lower your donor’s tax would be compared to the estate tax. If you decide to take this route to reducing the tax bite on your estate, you may consider staggering donations over a number of years so that you avoid the maximum donor’s rate of any one year.
However, where properties valued at over P2 million are concerned, you may find out that you prefer to sell the property to your children and pay the capital gains tax of 6 percent and the documentary stamp tax of 1.5 percent rather than the donor’s tax.
Take note, though, that if you undervalue the property to reduce the capital gains tax and the DST, the difference between the fair market value and the selling price will be considered a gift, and taxed accordingly.
(Next week: A matter of trusts)
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