Estate Planning To Minimize Estate Taxes

Maximize use of the $345,800 unified tax credit: †

• Every U. S. citizen has the right to transfer up to $1 million free of federal gift or estate tax. (There is no limitation on transfers between spouses so that property may pass back and forth between spouses with impunity).

• The $1 million equates to a $345,800 tax credit, so that while the tax on a $1million estate would equal $345,800, the unified credit would fully offset the tax.

• Consider also gifting $1 million of property while living to maximize use of the credit. This credit is "wasted" when, for example, all property is transferred to one's spouse at death. (See Example 1 of "The Benefits of a Tax Efficient Estate Plan").

Transfer ownership of your life insurance:

• Life insurance proceeds on policies you own are included in your gross estate for estate tax purposes. Inclusion of life insurance in an estate that is otherwise taxable may result in 41 percent or more of the proceeds being taxed.

• Life insurance proceeds may be excluded from your estate by naming a beneficiary other than the estate and transferring the policy and all the incidents of ownership therein, to the beneficiaries or to a trust.

• The transfer of all incidents of ownership requires particular care, however, especially as to any control the insured may have as trustee.

Note also that gifts of a policy made within three years of the insured's death result in the entire proceeds being included in the insured's gross estate. So, if you're going to gift life insurance, it is to your advantage to do it as soon as possible.

†The Economic Growth and Tax Relief Reconciliation Act of 2001 will gradually increase the amount of the unified credit to approximately $1.45 million by 2009. But in an interesting anomaly in the law, the estate tax is actually eliminated in 2010 and reinstated in 2011 with a unified credit of $345,800. Note, however, that the unified credit for gift tax purposes remains fixed at $345,800 for transfers to individuals other than spouses.

Consider a lifetime gift-giving program:

• The annual exclusion can remove from $11,000 to $22,000 per year per donee, from the donor's estate, without gift tax.

• If you give property with appreciation potential, the appreciation escapes tax in the donor's estate unless the donor retains a life or other interest in the property given.

• This is particularly viable when the estate of a surviving spouse is likely to be larger than the unified credit that will be available to the estate upon his or her death.

Avoid owning property jointly with your spouse:

• Property passing to a beneficiary at death receives a stepped-up basis equal to the fair market value of the property at death.

• Property passing to a spouse at death will also receive a step-up in value and will also qualify for the marital deduction. But if the property is jointly-owned, only one-half of the property will be stepped-up since only one-half is included in the estate.

· Sole ownership of property by each spouse affords the best planning opportunities and can prevent "wasting" the unified credit as illustrated in Example 1 (The Benefits of a Tax Efficient Estate Plan).

The Benefits of a Tax Efficient Estate Plan

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Assume that Donald and Daisy in Example 1 own the property listed below and that Donald dies in 2003. Also assume that Donald and Daisy own their property jointly, that Daisy does not remarry and dies some time after Donald.

In Example 2, Donald and Daisy own the same property, except that the house is owned as tenants-in-common and the cash and securities are owned by each spouse individually. Donald and Daisy have provided in their respective wills, however, that at death, their assets are to be transferred to a trust which provides income to the surviving spouse for as long as he or she shall live, with the corpus of the trust to be divided among their children at the surviving spouse's death.

	EXAMPLE 1		EXAMPLE 2
	Donald	Daisy	Donald	Daisy
House	$350,000	$350,000	$350,000	$350,000
Securities	550,000	550,000	550,000	550,000
Cash	100,000	100,000	100,000	100,000
Total Assets	$1,000,000	$1,000,000	$1,000,000	$1,000,000
Property Received From Spouse at Death	N/A	1,000,000	N/A	0
Marital Deduction	(1,000,000)	0	0	0
Taxable Estate	$ 0	$2,000,000	$1,000,000	$1,000,000
Federal Estate Tax Before Unified Credit	0	731,000	345,800	345,800
Unified Credit †	(345,800)	(345,800)	(345,800)	(345,800)
Federal Estate Tax, After Unified Credit	$ 0	$385,200	$ 0	$ 0
Federal Estate Tax, Both Estates	$ 0	$385,200	$ 0	$ 0
Estate Tax Saved in Example 2: $385,200

At first glance, it would appear that the estate taxes paid by both Donald and Daisy in Examples 1) and 2) should be the same because the total assets are the same in both cases.

However, Donald has wasted his unified credit in Example 1. By operation of law, all jointly-held property passes to the survivor at death. Because the survivor is Donald's spouse, the transfer qualifies for the marital deduction, which, when deducted from total assets, creates a -0- taxable estate for Donald and no resulting federal estate tax. But there would have been no federal estate tax even if the estate had equaled $1 million because the $345,800 unified credit would have offset the resulting $345,800 of federal tax. Worse, the transfer of another $1 million into Daisy's estate has now left her with an estate of $2 million - and a federal estate tax of $385,200. (Note: There would probably be a state estate tax in this example too.)

†The recently enacted Economic Growth and Relief Reconciliation Act of 2001 will gradually increase the amount of the unified credit to approximately $1.45 million in 2009. But in an interesting anomaly in the law. Estate tax is actually eliminated in the year 2010 and reinstated in 2011 with a unified credit of $345,800, an amount equal to the 2002 unified credit. Note however the unified credit for gift tax purposes remains fixed at $345,800 for transfers to individuals other than spouses.

Could Donald avoid creating a trust and pass the property directly to his children at his death and still preserve the credit?

Yes, though Donald may have reservations about passing his assets directly to his children.

What about probate costs in Example 2? Doesn't an Example 1 scenario avoid all probate costs?

Yes, it does. But the administrative costs and hassles associated with the probate process are exaggerated. Eliminating probate costs in smaller estates, where there are no estate taxes to pay, may make sense. But following that strategy in larger estates, as Example 1 illustrates, could well result in higher estate taxes.

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