If it's been a while since you dusted off your estate plan, now is the time to do it.
EGTRRA vastly changed the landscape of estate and gift planning. The amount that can
be transferred tax free to nonspousal beneficiaries is gradually increasing, and in 2010,
the estate tax will be repealed. That repeal will only be in effect for one year only, unless
Congress acts to extend the repeal provisions. In 2011, the estate tax returns at levels in
effect prior to EGTRRA.
You may think that estate planning is not important at this stage of your life or that your
estate is too small to justify estate planning. But if you own a house, life insurance, a
retirement account, or an interest in a closely held corporation or partnership, your estate
could be larger than you think.
Failure to plan your estate not only increases your heirs' potential tax liability, it forces
the state courts to parcel out your estate for you — in a manner which you may not like.
Without an estate plan in force, an impartial court will split up your assets, assign
guardians for your children, and dictate all other details in handling your estate. Your
involvement now is essential to your loved ones' futures.
With An Without An
Estate Plan Estate Plan
Your assets... You decide who gets what. Determined by applicable state law.
Your children... You choose the guardian. The court appoints a guardian.
Your You decide how and when Terms and timing set by law.
inheritance... beneficiaries receive their
Your business... You decide how the family Forced sale or liquidation may cause
business is to continue. financial loss and family hardship.
Your executor... You decide who will manage Court appoints an executor.
Your final You can reduce estate Costs may skyrocket due to
expenses... settlement costs. administrative expenses and
Gifts to Family Members
No one wants to see the bulk of their estate go to Uncle Sam. And yet, gift and estate
taxes can deplete a significant portion of your estate if you don't adopt an effective plan
to transfer your assets to others.
One of the best ways to gradually transfer your estate tax-free is to use the annual
exclusion and "gift" up to $12,000 per person in 2007 to an unlimited number of
recipients. If you and your spouse choose to "split" gifts, then $24,000 per person, per
year, can be given away tax free in 2007. Gift-splitting isn't necessary in community
If you'd like to make a gift to a grandchild (or anyone else), and wish to exceed the
annual exclusion amount, then you should make a direct payment to the providers for
education (tuition only) and medical expenses. Gifts of this nature do not count toward
the annual limit.
In certain circumstances, you can also exclude gifts of pre-paid tuition.
EGTRRA makes it more important than ever to coordinate gifting with your overall
estate plan. The biggest change is the creation of a differential between the estate tax and
gift tax unified credit, and the continuation of the gift tax after repeal of the estate tax.
Avoid making gifts of highly appreciated property that likely won't be sold before your
death. Left in your estate, it would get an automatic step-up in basis to fair market value.
This could save your heirs significant income tax when the property is eventually sold.
If you have stock that's temporarily depressed in value but has high appreciation
potential, consider giving it to your children now. The gift tax impact (which is
determined by fair market value on the date of the gift) will be reduced. When the
stock price recovers, you will enjoy a second benefit: the increase in value won't
increase your estate tax base.
One of the best ways to gradually transfer your estate is to use the annual exclusion and
"gift" up to $12,000 per person to an unlimited number of recipients. If you and your
spouse choose to split gifts, then $24,000 per recipient can be given away tax-free. Gifts
may be made directly to the donee or in trust for the donee's benefit. Many estates can be
completely transferred to others—free from tax—in this way over time.
There are special requirements when a trust beneficiary doesn't have a present interest
(i.e., does not enjoy current benefits from the trust property). Gifts to such trusts don't
qualify for the annual exclusions, so they are fully taxed. In the case of trusts set up for a
minor, annual exclusion gifts are allowed, but the minor must have full access to the trust
assets at age 21.
One possible solution to the "present interest" problem is to create a "Crummey" trust for
greater flexibility and control. This requires that you give each trust beneficiary a right of
withdrawal when funds are transferred to the trust. Transfers to the trust which are
subject to "Crummey" powers will qualify for the annual exclusions.
Or, consider creating a family limited partnership (FLP) or limited liability company
(LLC), to which you can transfer property (such as rental property) and then gift interests
to family members without relinquishing full control. The fact that the IRS may allow a
substantial valuation discount when the gifts are made makes this approach very
The GST Tax
Attention grandparents! Transfers to your grandchildren are also subject to the
generation-skipping transfer (GST) tax, which is imposed at a flat 45% for 2007. The
GST tax goes away in 2010... but will be resurrected in 2011 unless Congress acts first.
Each spouse has a lifetime GST exemption of $2.0 million in 2007 available to shelter
transfers from the GST tax. This amount corresponds to the estate tax exemption amount
and increases over time, until repeal in 2010. To see how the reform affects exemption
amounts, click here.
Post-gift appreciation escapes the estate tax.
To the extent of the $12,000/$24,000 per donee, per year annual exclusion, no
transfer tax is ever imposed.
Gift tax paid reduces your taxable estate. (Limited exceptions apply.)
Post-gift income produced is taxed to lower tax bracket donees.
The $12,000/$24,000 gift tax annual exclusion can still be available to you for
transfers to minors even though their current access to the trust property and its
income is severely restricted.
Gift and Estate Taxes
Every estate may exclude a certain amount of property from estate taxes. In 2007 that
amount is $2.0 million. Furthermore, you may give away up to $1 million during your
lifetime tax free, but doing so will reduce the amount you are able to transfer tax free at
death. This gift tax exemption applies to gifts that do not qualify for the annual exclusion.
The amount you can transfer tax free at death will increase to $3.5 million in 2009. In
2010, both the estate tax and generation skipping transfer tax are repealed. However, the
gift tax exemption equivalent is permanently capped at $1 million. (See table below.)
For both you and your spouse to take full advantage of your own estate tax exemptions,
you each must own property that has a value equal to the exemption for the year of death.
To ensure this result, consider making tax-free gifts to your spouse (they qualify for the
unlimited marital deduction). Special planning applies to states with community property
Prior to 2010, lifetime gifts in excess of annual exclusion amounts will be aggregated
with and use up a portion of your estate tax exemption. However, because the gift tax
exemption is smaller than the estate tax exemption, you could end up with a taxable gift
even if no estate tax is due at death.
If you wish to make gifts of more than
$1 million, consider transferring assets to heirs in exchange for an installment note.
The note can be forgiven (or distributed to the heirs) at death and be sheltered by
the additional estate tax exemption (or be free from estate tax if repeal occurs).
However, the transfer will be subject to income tax, so we need to compare the costs
and benefits of this strategy.
Estate, GST, and Gift Tax Exemptions
Estate/GST Tax Exemption
2007 & 2008 $2,000,000 $1,000,000
2009 $3,500,000 $1,000,000
2010 Estate/GST Tax Repealed $1,000,000
2011 & after $1,000,000 $1,000,000
If you are married and your estate exceeds your estate tax exemption, consider using the
unlimited estate tax marital deduction to reduce your estate to within the excludable
limits. But, make sure that you don't over-fund the marital deduction (by keeping assets
whose value is less than the exemption amount). Otherwise, you won't get the full benefit
of your exemption.
You may wish to create a so-called "marital trust" funded with just enough assets to
ensure that no estate tax is due upon the death of the first spouse. The remainder funds a
credit shelter or bypass trust for the primary benefit of the children, which can also be
available for your spouse during his or her lifetime.
Also, look into the qualified terminable interest property (QTIP) marital deduction trust.
QTIP trusts guarantee that your assets will pass to your children when your spouse dies.
For a more complete list of trusts used in estate planning, see below:
Commonly Used Trusts
Type Purpose Benefits
Credit Created at death to hold and manage Distributes assets free of estate tax to heirs at a
shelter or assets for your heirs in an amount predetermined age.
By-Pass equal to the unified credit equivalent.
Irrevocable Created by gift to manage assets you Keeps trust assets out of your estate if you give up all
Living Trust transfer, for beneficiaries you control. Post-gift appreciation is also excluded. Can be
designate. Terms are specified at your set up so that you pay the taxes on trust income,
discretion. maximizing the amount available to beneficiaries.
Revocable Protects and manages your assets in Helps you avoid probate and gives you privacy.
Living Trust the event of your incapacity. Becomes
irrevocable at death and provides for
Insurance Owns life insurance policies on your life. Keeps insurance proceeds out of your estate. Can
Trust Manages and distributes policy proceeds loan proceeds to your estate to help it meet liquidity
in accordance with your wishes. needs, such as to pay estate tax.
Charitable Holds appreciated property you transfer Gives you an immediate income tax deduction, avoids
Remainder for the benefit of a charity. Makes capital gains tax, provides you with annuity
Trust annuity payments to you (or other payments, and keeps the transferred property out of
beneficiaries) and transfers any your estate.
remainder to the charity at your death.
QTIP Created at death for the benefit of your Qualifies for the estate tax marital deduction. Gives
(Qualified spouse and children. Pays all trust you complete control over the final disposition of your
Terminable income to your spouse for life. property. Often used in second marriages to protect
Interest Remainder then passes to your interest of children from a previous marriage.
Scheduled increases in the estate tax exemption may result in the credit shelter trust
being funded with the majority of the assets, leaving little or nothing for the marital trust.
This could be a big problem for estate plans which were set up before 2002. If you
already have a "bypass trust" estate plan in place, review it now to ensure your property
will still pass in accordance with your wishes.
Carryover Basis Rules
With the repeal of the estate tax in 2010, assets transferred to your heirs will be subject to
modified carryover basis rules. This could significantly impact the income tax potential
on the assets. The new legislation requires heirs to calculate how much their inherited
assets have increased in value so they can compute the capital gains taxes owed when the
assets are sold.
Generally defined as the purchase price of the property minus certain adjustments, basis
is used to calculate the amount of capital gains tax owed when an heir to an estate sells
the property. Under the step-up provision, the basis of inherited property is increased to
the fair market value (FMV) of the property on the date of death. In practice this means
that, when inherited property is sold, the stepped-up basis—sometimes referred to as the
"fresh start basis"—is subtracted from the proceeds of the sale. Heirs then owe capital
gains taxes only on the remaining amount.
Under carryover rules, inherited property receives a basis equal to the amount the
deceased originally paid for the item. Depending on how much the property rose in value
between the time of purchase by the deceased and the time of sale by the heir, the
recipient of the property could owe much more in capital gains taxes under the carryover
basis provision than under step-up basis rules.
In 2010, carryover basis applies to assets above $3 million inherited by the spouse of the
deceased, and assets of more than $1.3 million inherited by anyone other than the spouse.
Inheritances below these limits are subject to the step-up basis rules. Following the
expiration of EGTRRA provisions on December 31, 2010, the step-up basis is scheduled
to go back into effect, and estate tax will be assessed on property in excess of $1 million,
with a maximum tax rate of 55%.
The carryover basis rules can create quite a dilemma for people trying to do estate
planning under both pre-estate tax repeal and post-repeal rules. Contact us to review your
estate plan to minimize your tax risks.
Life Insurance Proceeds
Life insurance proceeds are subject to estate tax if you retain any powers over the policy
(such as the right to change the beneficiary or borrow against the policy) or the proceeds
are made payable to your estate.
You can transfer a policy to certain life insurance trusts at least 3 years before you die or
give money to the trust to buy a new policy and pay the premiums. The proceeds will be
free from estate tax, although your initial gift and the premiums you pay may be subject
to the gift tax.
If the trust is properly structured, the insurance proceeds will still be available to meet the
liquidity needs of your estate.
Where You Live Makes a Difference
Where you decide to retire can be very important because state income and estate taxes
can have a pronounced impact on your overall tax picture.
Changing your domicile (residency) to a state with a more favorable tax climate can save
you a lot of tax dollars. For example, some states don't tax retirement account
distributions, while some states assess estate tax at much higher marginal tax rates than
A state can tax you and your assets only if you are domiciled in that state. To determine
your residency status, states will consider factors such as:
Where you are registered to vote;
Where your automobiles are registered;
Where you own real estate; and
Where you lived for most of the tax year.
Contact us if you wish to discuss residency issues.
Choosing An Executor Or Trustee
Once you've written your will and formulated your financial plan, you need to select a
competent executor and perhaps a trustee to ensure your wishes are carried out. Basically,
you have two choices. You can 1) use the services of a financial institution trust
department or 2) name a family member or friend.
Institutions offer the benefit of technical know-how and continuity over time. However,
they may charge high fees, use conservative investment policies, and be unresponsive to
the needs of your beneficiaries since they must adhere to established corporate policies.
Selecting a family member or trusted friend may reduce or eliminate fees and add a
personal touch to the process. However, choose wisely! The duties and responsibilities
involved are significant, including filing tax returns, making complex tax elections, and
implementing investment strategies.
Just because a family member is the oldest surviving sibling or willing to serve, doesn't
mean he or she will be a good choice for the role. A successor executor or trustee should
also be named. Then, if the individual chosen can't or won't continue to serve, you've
provided for a smooth transition.
The good news is we're living longer. The bad news is we may not be healthy. If you
were to become terminally ill and could not communicate, what type of medical
treatment would you want? Would you want doctors to keep you alive no matter what, or
would you want your life support system turned off if the situation looked hopeless?
Make your desires regarding medical treatment known with a legal document known as a
living will. The living will allows you to be specific about your desired treatment in the
event of your incapacity.
It's also wise to go one step further. Make sure your wishes will be honored by the
medical establishment by appointing a family member or friend as your legal
representative for making healthcare decisions. This choice is made by executing a
medical power of attorney. Choose someone whom you believe can effectively make the
tough decisions that may be called for.
Don't hide your living will in a safety deposit box! Give copies to your doctor, lawyer,
and adult children, as well as to any hospitals that will care for you. Many lawyers that
are already involved in an estate planning effort will prepare a living will at little or no
Several not-for-profit advocacy groups also make the necessary forms available. Be sure
to use a form which is enforceable in your state! You can download state-specific forms
free of charge at www.partnershipforcaring.org.
Execute a living will and medical power of attorney now if you haven't already done
so. Both you and your family can benefit greatly if you become seriously ill.
Business Succession Planning
Only about one in three closely-held businesses successfully pass on to the next
generation. A lack of proper transition planning is often why businesses fail after
founders retire, become disabled, or die.
If you've spent the greater part of your life building up a profitable business, don't let it
go to ruin. Implement a business succession plan.
At a minimum, a good plan should help you accomplish the following:
Transfer control according to your wishes.
Carry out the succession of your business in an orderly fashion.
Minimize the tax liability for you and your heirs.
Provide economic well-being for you and your family after you step aside.
A succession plan should be part of your overall financial plan, encompassing all of your
needs and objectives. Tax minimization strategies play a key role in the overall planning
Adopting the following strategies may help lower your tax liability:
Gift stock to family members. Begin now so ownership can be transferred without
incurring unnecessary transfer taxes.
Employ a buy/sell agreement that fixes the estate tax value of your business. An
effective agreement provides estate tax liquidity and gives your successors the
means to acquire your stock.
Create an employee stock ownership plan (ESOP), and sell your stock to the plan.
Special rules allow you to sell your stock to the ESOP and defer the capital gains
tax if you reinvest in qualified securities. Ownership can be transferred to your
employees over time, and your business can obtain income tax deductions for the
Plan to qualify to take advantage of the estate tax installment payment option. It
allows you to pay the portion of your estate tax attributable to your closely-held
business over a period of up to 14 years. Artificially low interest rates apply
during the tax-deferral period. Special rules apply.
If you want to keep the income rolling in without having to show up for work every day,
start planning early.
Tax Strategies To Protect Your Future
Consider an IRA for children with earned income.
Determine which type of IRA is best for you, establish an account before the end
of the year, and make your contribution before the due date of your tax return to
obtain a current year deduction.
Be mindful of distributions from your IRAs. Before age 59½, withdrawals are
generally subject to penalty. But, once you reach age 70½, you must withdraw
certain minimum amounts. How much you withdraw should be based on an
analysis of your life expectancy and other sources of income.
Think about the best ways to gradually transfer your estate tax-free. Consider
establishing a gift program under which you and your spouse transfer a combined
$24,000 each year to any number of recipients.
Make sure your spouse owns sufficient assets to take full advantage of your estate
tax exemption if he or she predeceases you. Make gifts to your spouse that qualify
for the marital deduction if necessary.
Contribute the maximum amount allowable to a tax-deferred retirement plan,
including "catch-up" contributions if you are 50 or older.
Create a succession plan. For succession planning ideas, see my other resources
on business exit strategies.
Set up a trust to meet your long-term financial goals.
Consider your life insurance needs in light of the estate and gift tax changes. Life
insurance can provide a valuable hedge if you die before the estate tax unified credit
increases sufficiently to shelter your estate from taxation.