ESTATE TAX BASICS

For clients facing the potential of estate tax, the dangers of ignorance are enormous; but the benefits of simple planning are correspondingly great.

The "Unified Credit."

Under the federal tax code, every taxpayer is currently permitted to transfer a total of one million dollars ($2 million) during his or her lifetime or at death, free of tax. It is called the "unified" credit because to the extent to which the privilege is not used during the taxpayer's lifetime, it remains available to be used at the time of death. Thus, if Fred gives away $600,000 during his lifetime, and has $3,000,000 left at the time of his death, then he can still shelter $400,000 of that $2,000,000 and will be taxed on $2.6 million.

The Marital Deduction.

One other major feature of the tax code is the marital deduction, which permits every taxpayer to transfer any amount to his or her spouse without any tax consequence, during his or her lifetime, OR at the time of his or her death. The unified credit is irrelevant, if the transfer is to a spouse.

How They Will Get You If You Don't Plan.

If you are fortunate enough to have an estate approaching or exceeding $1 million, you could carelessly take hundreds of thousands of dollars from your children and grandchildren and give it to the federal government; or, for a legal fee which, by comparison, is truly trivial, you can avoid that result. Please let me explain.

Suppose your estate consists of a residence valued at $300,000, securities of $200,000, other property of $50,000 and life insurance of $200,000. You and your spouse leave everything to each other and on the death of the survivor, to your children. If your estate grows at 7% a year compounded annually, then in 10 years it will double to $1.5 million! One of you dies, and there is no tax because of the marital deduction. But in 15 years the estate is $2 million, the survivor dies, and after the unified credit there is a taxable estate of $1 million. Tax: $370,000!

But there is an Answer!

Didn't I say every taxpayer can claim the unified credit of $1 million? I did! Your mistake was in allowing the survivor to become the owner of an estate worth twice that amount. In order to avoid that, you divide the estate between you before either of you dies -- and that means now, before either of you has a chance to die. Then each of you transfers your separate estate to a credit shelter trust. When the first Donor to die passes away, his or her Trust provides that his or her Trust Estate is to be administered for the benefit of the survivor, and can be exhausted, if necessary, for the needs of the survivor. But if it is not exhausted, then on the death of the survivor, it goes to the children. In that way, it never becomes part of the survivor's estate for tax purposes, and so it is never taxed! The other half of the estate, which IS owned by the survivor, is sheltered by the survivor's own claim of the unified credit.

Other Tax Planning Techniques.

If your estate is still too fat, you can resort to other strategems for avoiding tax.

The Annual Exclusion. Each taxpayer may give $10,000.00/year to anyone. In practical terms, this means you and your spouse may each give each child and each grandchild $10,000.00 every year in order to prevent your estate from growing too quickly. If you don't want to give it to them outright, you may establish an irrevocable trust to administer the gifts until they attain a certain age. You may be the trustee(s).

Life Insurance Trusts.

Proceeds of policies of life insurance owned by the insured will be treated as part of his taxable estate. This can be avoided by transferring ownership of the policy to a trust created for that purpose.

Charitable Remainder Trusts.

A future interest in appreciated property is contributed to a charity. A deduction against current income is taken and the property is retained until the Donor dies.