Federal taxes usually due at death have recently grabbed the attention of the living. A number of Republican lawmakers, as well as GOP presidential hopeful George W. Bush, want to do away with the federal estate tax. Bush's plan would phase out the federal tax on large estates over an eight-year period.
Why the drive for repeal? Critics of the tax insist it's unfair. Congress did make some changes to estate tax laws when it passed the Tax Relief Act of 1997. Under the '97 law, the unified credit was raised over a number of years. In 2000, for example, the credit increased to $220,500. As a result, use of the credit now exempts the first $675,000 of an individual's estate from taxes ($1.35 million for married couples). Also, the credit increases over several years with the effective individual exemption reaching $1 million ($2 million for legally married couples) in 2006.
But although the current talk seems to revolve mainly around repeal, few analysts expect Congress to go quite that far. "Wiping out the estate tax is a very hard sell to make," says estate planner Beverly Brooks, who was president of the Society of Financial Service Professionals, and is currently a chartered life underwriter and an accredited estate planner with BrooksBittner & Associates LLP, in Dallas. Instead of a total repeal, tax experts are expecting lawmakers to make some additional adjustments to the existing unified credit.
One of the many tax experts who are predicting that efforts will be made to improve upon the already existing law is Evelyn Capassakis, a partner in charge of the trusts and estates group for PricewaterhouseCoopers in New York City. She says there is a distinct possibility that lawmakers will eventually decide to make the $1 million exempt transfer amount immediately available instead of having to wait until 2006.
Joan Szabo is a writer in Great Falls, Virginia, who has reported on tax issues for more than 13 years.
Planning Takes A Back Seat
Despite these predictions, many entrepreneurs and taxpayers are in a quandary over what estate tax-planning steps to take now. Does it make sense to go ahead with tax-lowering strategies, or to wait for Washington to enact changes?
While they say it may seem self-serving, estate planners recommend taking steps now to do some estate planning rather than waiting for Congress to act. If you're concerned about changes in the law, you'll want to employ strategies that can be undone, says Capassakis.
Terence Stanaland, a CPA and attorney with Johnson Peddrick & Stanaland PLLC, a firm specializing in estate-planning, located in Greensboro, North Carolina, is in agreement that planning shouldn't stop. He recommends making use of strategies that don't result in outlaying money (excluding the transaction costs). "It's always possible to revisit an estate plan and make the necessary alterations if the federal estate tax laws do undergo more changes," he adds.
Regrettably, taxpayers are using the prospect of legislative action as reasoning to halt their estate tax plans, says Brooks. "There's a false sense of security that estate taxes aren't going to be owed," she says. As a result, the heirs of those procrastinating may end up paying more in federal estate taxes than they would normally pay. In addition, "it's unrealistic to expect people to make quick decisions while they are still grieving," she says.
All The Right Moves
That said, who should consider strategies to lower estate taxes? Estate planners say if your investments and the value of your business are on the rise and now total more than the $675,000 exempt transfer amount or will do so in the immediate future, it's time to do some planning. So, although the unified credit is rising and Congress may push it higher, "it won't increase nearly as fast as the value of an individual's business and investments," says Brooks.
In light of anticipated legislative changes, what kind of steps should you take now? Here are some to consider:
- Reconsider the practice of leaving all your assets to your spouse. By law, the federal unlimited marital deduction allows taxpayers to transfer any amount to a spouse during their lifetime or at death free of federal gift and estate taxes. But, by leaving everything to your spouse, you've delayed the necessary planning, and you may have lost a valuable tax benefit.
Here's why: Although there is no tax due at your death, your unified credit, which exempts $675,000 of your estate from federal taxes, disappears when you die. So, when your spouse passes away, only his or her credit is available-so that only $675,000 can pass untaxed to your heirs, rather than the $1.35 million that would go untaxed if both credits were used. As a result, your children and other heirs will be hit with a sizable tax bite. Remember: holdings exceeding $675,000 are subject to federal taxes as high as 55 percent.
To avoid this problem, consider planning steps that will allow you to leave a portion of your estate to your children.
- Use a disclaimer in your planning. If you still want to leave everything to your spouse, it's possible to structure an estate plan that anticipates "the use of disclaimer," says Stanaland. Here's how it works: The husband gives everything to the wife. However, she has the right to disclaim the property passing to her. If this takes place this year, she would be able to disclaim $675,000 in assets. This amount would then go into a trust, reducing the amount of federal taxes owed. Keep in mind that disclaimers must be implemented within a set period of time after death, something you should ask your advisor about.
Stanaland calls this strategy "a wait-and-see estate plan," because it anticipates a possible change in the federal estate tax laws. In this example, he says, "If the estate tax is repealed, the wife can inherit everything the husband has left her with no taxes due. However, if the estate tax is still with us, then she can disclaim the $675,000 exemption."
- Consider establishing a living trust. With a living trust, you and your spouse can become trustees and have full use of, and access to, the assets in the trust. If you establish the trust and for some reason become incapacitated, the co-trustee can manage the assets. In addition, assets in the trust are not subject to probate, which can sometimes be costly. As you know, probate is a legal process designed to protect heirs. A living trust can be set up to continue after your death so that your spouse has access to the assets. At your spouse's death, the assets can be distributed to other heirs without passing through another taxable estate. The net effect of this strategy? You substantially reduce the federal estate tax bite.
- Look into setting up a life insurance trust. Why? Because it will allow you to place insurance in the trust and exclude the policy from your estate. You fund the trust, which pays premiums on the policy. With this strategy, the policy's proceeds pass to the intended beneficiaries free of all federal estate and income tax burdens and can be used to pay estate taxes on other assets. A life insurance trust may be funded with most types of life insurance policies, including group or individual term, survivorship or whole life.
- Check out the special deduction for family-owned businesses. If you have a family business, you'll want to see if you qualify for a special federal estate tax deduction established for family-owned firms. Up to $675,000 of the adjusted value of the business may be deductible, and the deduction, together with the annual exclusion amount, may protect up to $1.3 million of family business assets from estate taxes. The adjusted value of the family-owned business interests typically must exceed 50 percent of the descendant's adjusted gross estate.
There are a number of other requirements as well, so check with your advisor to determine whether you qualify. Stanaland says very few of his clients actually qualify for the deduction because of the various requirements that must be met.
But Wait, There's More
If you take advantage of some of these planning steps, don't assume you'll never have to do it again. Estate planners say you should periodically review your plan and consider changes in your financial situation, your business holdings and events such as birth, death, marriage or divorce.
Devising individual estate plans to trim federal taxes is no simple matter. Make sure you sit down with your lawyer and tax advisor to get the job done. It provides more than peace of mind; the relatives you leave behind will surely appreciate the effort.
- BrooksBrittner & Associates LLP, 5956 Sherry Ln.,
#615, Dallas, TX 75225, (214) 363-7188
- Johnson Peddrick & Stanaland, (336) 574-9720, fax:
- PricewaterhouseCoopers, (212) 259-2363