Tax Tips
Time to Renew Attention to Estate Tax - November 2008
Richard Scrivanich - Partner
With the Democratic majority firmly entrenched in Congress, it appears that the prospect of an estate tax repeal is less likely than it was with a Republican majority.
Therefore, it seems that the federal estate tax will remain if effect, at some level. Tax planning can reduce the burden your heirs may face. To plan efficiently, you should know the basics of the current law.
Repeal and reappearance
A tax credit now exempts amounts up to $2 million from federal estate tax. That was the level in 2006 and it is scheduled to remain through 2008.
Under current law, the exempt amount will rise to $3.5 million for estates of decedents who die in 2009. In 2010 the federal estate tax is slated to be repealed - but the tax will appear again in 2011, with an exempt amount of $1 million.
Practically speaking it appears unlikely that the exemption will revert to $1 million; it might be set at $2 million or at some higher level. Similarly, in 2011, the maximum tax rate on estates, now 45%, is scheduled to go back up to 55% (60%, including a surtax on some estates); but it may not go that high. In fact, there have been proposals to drop the estate tax rate below 45%.
Faced with such uncertainty, planning is difficult. One approach is to plan as if death will take place this year, with the current exempt amount and tax rate. Then your plan can be modified if and when the law changes.
The exemption
Under current as well as prior law, you can leave unlimited amounts to a spouse and to charity, free of estate tax. The exemption refers to the amount you can leave to other heirs and beneficiaries. At present, the first $2 million is tax-free while excess assets are taxed at 45%.
For example, if someone dies in 2008 and leaves $3 million to his child, his bequest is $1 million over the exemption amount, and his estate would owe $450,000 in federal estate tax (45% of $1 million).
Prudent Planning
Therefore, under current law, a married couple can leave up to $4 million to their heirs (who might be their children), free of estate tax.
Suppose a couple has $4 million worth of assets: a house, IRAs, securities, and so on. The first spouse to die could leave $2 million to the children.
If the survivor also dies with $2 million in assets, the children could wind up with the entire $4 million, and no federal estate tax would be due.
Title tactics
There are, however, several obstacles that could interfere with this type of planning. One obstacle might be the ownership of assets.
Suppose, for example, $3 million of the couple's assets are held jointly, with right of survivorship, while each has a $500,000 IRA. Say the husband, Carl, dies first. His spouse, Diane, will automatically become the sole owner of the joint assets, in addition to her IRA. If she dies soon after Carl, she will thus have a $4 million estate.
Assuming today's laws are still in effect, her estate will be $2 million over the exemption amount and will owe $900,000 in federal estate tax, at the 45% rate.
Therefore, part of a successful estate tax plan is seeing that assets are owned in such a way that they can pass to intended heirs and utilize the federal tax exemption.
A Matter of trust
Another obstacle that may arise is a desire to provide adequately for the surviving spouse.
Suppose in the above example Diane is much younger and healthier than Carl. He is concerned that she will outlive him by many years. Even if Diane has $2 million in assets after Carl's death, that might not be enough to assure her of a comfortable lifestyle for decades.
One popular estate planning strategy is the use of a "bypass" trust. In our example, Carl leaves $2 million to the trust. The trust beneficiaries include Diane and the couple's children.
This trust can use up Carl's $2 million estate tax exemption. At Diane's death, the trust assets will be included in her estate so they will "bypass"estate tax altogether. Diane can leave another $2 million to the children, so the entire $4 million can pass to the next generation, tax-free.
In the meantime, the trustee of the bypass trust will be able to provide Diane with trust assets, if necessary, so that Diane is less likely to face any financial stress.
The above example is necessarily a simplified description of what is certainly a very exacting planning process. To get the desired result, it is crucial to work with knowledgeable legal and tax professionals.
If you have any questions regarding estate tax planning or any other tax matter, please feel free to give me a call at (562) 698-9891.
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Some of the articles included here were written in a prior
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relate only to the year for which the article was written and could be different
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