Estate Tax Planning - Federal Estate Tax
The starting point here is to give you an understanding/overview of the federal estate tax issue. The federal estate tax is a tax on your right to transfer property at your death. It consists of an accounting of everything you own or have certain interests in at the date of death. The fair market value of these items is used, not necessarily what you paid for them or what their values were when you acquired them. The total of all of these items is your "gross estate." The includible property may consist of cash and securities, real estate, insurance, trusts, annuities, business interests and other assets.
Once you have accounted for the gross estate, certain deductions (and in special circumstances, reductions to value) are allowed in arriving at your "taxable estate."
These deductions may include mortgages and other debts, estate administration expenses, property that passes to surviving spouses and qualified charities. The value of some operating business interests or farms may be reduced for estates that qualify.
The amount of the exemption for federal estate taxes has changed over the years. As recently as 2008, the exemption was $2,000,000 per person. In 2009, the exemption was $3,500,000 per person. There was no estate tax in 2010. The law was scheduled to go back to $1,000,000 in 2011; however, Congress took action and changed that late last year.
In December, Congress passed a bill that includes changes in the federal estate tax exemption amounts. For decedents dying in 2011 and 2012, the act greatly reduces the reach of the estate tax by granting estates a $5.0 million exemption for property subject to the tax. In 2009, the last year in which there was an estate tax, the exemption was $3.5 million, so this is a significant increase. In addition, the act introduces the concept of exemption "portability" between spouses.
If one spouse does not use all of his or her $5 million exemption, it may be used by the estate for the surviving spouse, effectively creating a $10 million exemption for married couples. The few estates that exceed this $5 million/$10 million threshold will be subject to a new 35% tax rate, considerably lower than the 45% rate that prevailed before 2010.
Notice that the act applies to 2011 and 2012. What happens after that depends ultimately on what Congress decides.
Because of this uncertainty, I recommend that you work with your attorney to incorporate estate tax planning protections in your planning. A very common tool is known as a "disclaimer trust."
A disclaimer trust’s value is best explained by example. Assume a couple owns all of their assets jointly. When the first spouse dies, all of the assets pass to the surviving spouse. No estate tax is due at this time because of the unlimited marital deduction allowed. The survivor, however, now owns all of the couple’s assets as an individual. At the survivor’s death, all of the assets will be taxable in his or her estate, and the survivor will only be able to use his or her individual estate tax credit.
In order to make use of the estate tax credit of the first spouse to die, some property (limited by the exemption amount) must pass to someone other than the surviving spouse. Usually, this is done using a disclaimer trust, as a part of the couple's wills.
A disclaimer trust is established at first death only when the surviving spouse elects to use it. If that person decides not to, it is inapplicable. This results in a very flexible tool for the survivor’s use and estate tax planning, which is very helpful, as none of us knows when we are going to die, or what estate tax problems we may have at that time.
The disclaimer trust allows for the assets to be available solely to the surviving spouse, but not have them included in the estate. The income generated by the assets placed into the disclaimer trust will go directly to the surviving spouse for the rest of his or her life. Moreover, the surviving spouse, along with a co-trustee of his or her choice, has control of the trust. At the passing of the surviving spouse, the disclaimer trust is terminated and the assets are passed to your heirs as you direct in the documents.
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Required Disclosure Pursuant to IRS Circular 230: Pursuant to requirements imposed by the Internal Revenue Service, any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code; or (2) promoting, marketing or recommending to another party any transaction or matter addressed in this communication.