| Suppose
you own a home, have life insurance, own a business or have a
substantial retirement account with your employer. Without knowing it,
you may need a lawyer. It's not because you are on the verge of being
sued, rather it's because your net worth may be more than you realize
and your family may be faced with paying hefty estate taxes.
Let's consider an example. Say our married
couple owns a home worth $800,000, has life insurance with a death
benefit of $1.5 million, has another $500,000 in a retirement plan, a
business worth $700,000 and general investments totaling $900,000.
If the husband in our example dies and
leaves everything to his wife, there will be no federal estate tax.
This is the case regardless of the amount because the federal estate
tax law allows an unlimited amount of property and money to pass to a
spouse free of estate tax. Assume now that our surviving wife has
inherited the $4.4 million-dollar estate and lives off of the earnings
for the rest of her life.
When our surviving spouse dies, her will
leaves the entire estate to her children. In 2009, the children would
not have been taxed on the first $3.5 million worth of property they
inherited from their mother because the federal law granted each of us
a credit that shielded this amount from federal estate tax. This $3.5
million exemption applied to those who died in 2009. The children would
have, however, paid federal estate taxes on the amount in excess of
$3.5 million, or in our example $900,000. The tax rate in 2009 was 45%
percent, which meant that the children would have paid roughly $405,000
in federal estate taxes.
The solution to this dilemma is to do a
little planning before the first spouse passes away. That is, instead
of leaving his entire estate to his wife, the husband in our example
could have changed his will so that an amount up to the first $3.5
million of his estate would have passed into a trust for the benefit of
his wife. The trust could say that all of the earnings on the trust
fund would be paid to his wife. In addition, any portion of the trust
could be used if needed to provide for his wife's health and support.
Upon his wife's death, the balance of the trust would be paid to the
children. In estate planning lingo, such trusts are known as "Bypass
Trusts" or "Credit Shelter Trusts" and they can be created as part of a
so-called living trust or established as part of your will. The exact
terms of such a trust can vary. However, the key is that a trust like
the one described will not be included in the surviving wife's federal
estate when she later dies. As such, when our husband dies, the first
$3.5 million that is left in trust escapes federal estate taxes because
it is below his $3.5 million credit. The remainder of the estate would
pass to the surviving spouse and escapes federal estate taxes because
of the rule that permits an unlimited amount of property to pass to a
spouse free of federal estate taxes.
The most important aspect of this plan kicks
in when the surviving spouse dies. At that point, any assets in the
"Bypass Trust" created by her husband are not included in her federal
estate. Therefore, as long as the assets she owns in her own name are
valued at less than $3.5 million, there would be no federal estate tax
upon her death. As such, each spouse's estate escapes federal estate
tax and our couple passes an extra $405,000 to their children.
The upshot of all of this is that if both
spouses make full use of their $3.5 million credits, they can pass $7
million of property to their children without federal estate tax. With
estates of this size, the savings can amount to more than $1.5 million.
2010 UPDATE: By virtue of the
Economic Growth and Tax Relief Reconciliation Act of
2001 signed into law by President Bush on June 7, 2001, the federal
estate tax has been eliminated for estates of those dying in the year
2010.
However, the current law has a “sunset” provision that reinstates the
tax in 2011 with a $1 million exemption and a maximum tax rate of 55%.
Some advisors believe that Congress will
take action to reinstate the federal estate tax at 2009
levels retroactive to January 1, 2010, but the future of the federal
estate tax is certainly uncertain. Stay tuned.
The important message is that those who made
an estate plan based on the federal estate tax law as it existed prior
to 2010 should have those plans reviewed immediately as they may not
have anticipated this temporary estate tax repeal and, as such, the
plan they have in place may yield unanticipated results.
Read more about the future of the Estate Tax >
Last Revised 2/28/2010
<
Previous Page
|
