For professionals and their spouses who have avoided estate planning for themselves and their families for any number of reasons, Congress just issued a "wake up call" of sorts by changing the estate and gift tax laws. The changed laws are a hearty invitation to reduce your estate taxes for those wishing to partake.
Many of you may already know that each person can pass up to $600,000.00 of property to his or her heirs without incurring any federal estate tax. Many of you may also know that the $600,000.00 dollar amount is increased to an unlimited amount, if all of your property is given to your surviving spouse. This unlimited gifting to a spouse is commonly referred to as the marital deduction. Once upon a time, $600,000.00 may have seemed like a fairly sizable estate that was not easily attained; however, when you consider that life insurance proceeds count towards the $600,000.00 threshold, the long term effects of inflation, climbing real estate values and soaring financial markets (which affect personal investments both inside and outside of retirement savings) you realize that many people who consider themselves in the "middle class" are in fact millionaires.
The new law addresses these concerns by gradually raising the amount free from estate and gift taxes to $625,000.00 in 1998, $650,000.00 in 1999, $675,000.00 in 2000, $700,000.00 in 2002, $850,000.00 in 2004, $950,000.00 in 2005 and $1,000,000.00 in 2006 and thereafter.
The goal for many professionals is to cut estate tax liabilities by reducing the size of their estates.
One popular method used to achieve this goal is to establish what is known as a credit shelter trust or a family trust. In effect, the credit shelter/family trust estate plan doubles the amount which can pass to your heirs free from federal estate tax. By the year 2006 this will mean that by taking advantage of the credit shelter/family trust plan, a family can pass up to $2,000,000.00 to the next generation without incurring federal estate tax. A similar tax savings device can be used during your lifetime by transferring assets to your heirs and exhausting a portion of the exemption amount as assets are transferred. This technique should be considered by those people who have assets that are likely to appreciate over time and who can afford to part with such property before death. The advantages of a credit shelter/family trust plan can be shown by example.
Mr. and Mrs. Shortsight
Mr. Shortsight has a $2,000,000.00 estate while Mrs. Shortsight has no estate. Upon Mr. Shortsight's death in 2006, all of his assets pass to Mrs. Shortsight. By taking advantage of the marital deduction, Mr. Shortsight's estate pays no federal estate tax. Shortly thereafter, Mrs. Shortsight dies, leaving a $2,000,000.00 estate. The first $1,000,000.00 of assets in her estate is exempt. Unfortunately, the next $1,000,000.00 is not, and so a federal estate tax of approximately $345,000.00 is owed.
The problem? Mr. and Mrs. Shortsight only took advantage of Mrs. Shortsight's exemption and wasted Mr. Shortsight's exemption.
Mr. and Mrs. Wiser
Mr. Wiser has an estate valued at $2,000,000.00. Pursuant to Mr. and Mrs. Wiser's estate plan, upon Mr. Wiser's death in 2006, $1,000,000.00 of assets passes directly to Mrs. Wiser and the remaining $1,000,000.00 passes into a separate family trust. The trust pays income to Mrs. Wiser during her lifetime. She may receive principal payments to maintain her lifestyle.
As a result of the trust terms in Mr. Wiser's will, the $1,000,000.00 that flows into the family trust does not qualify for the marital deduction. The $1,000,000.00 that goes to Mrs. Wiser is treated as a marital deduction. The net result of this is that Mr. Wiser has a taxable estate of $1,000,000.00 ($2 million gross estate less $1 million marital deduction), but because of his $1,000,000.00 estate tax exemption, no tax liability arises. Since the $1,000,000.00 in the credit shelter/family trust is included in Mr. Wiser's estate but not in Mrs. Wiser's estate, her estate drops from $2,000,000.00 to $1,000,000.00. As a consequence of Mrs. Wiser's $1,000,000.00 exemption no tax liability arises on her death. A total of $2,000,000.00 can pass to the Wiser's heirs ($1 million from the family trust and $1 million from Mrs. Wiser's estate) completely free of estate tax. The planning works this way regardless of whether Mrs. Wiser survives Mr. Wiser or vice versa.
By using the family trust, Mr. and Mrs. Wiser saved $345,000.00 in federal estate taxes, which went right into the pockets of their heirs and not to Uncle Sam.
The Wisers do give up something in receiving this tax advantage. Mrs. Wiser does not have free access to the funds in the family trust. Also in order to benefit from such planning, assets will need to be titled in each spouse's separate individual names. Retitling assets in this way may cause some concerns. Some spouses may be emotionally reluctant to transfer certain assets like a family home. Certain assets are not suitable for transfer, like stock in a professional's closely held business, or retirement plans. Placing assets in the individual name of a professional may expose those assets to creditor claims or malpractice claims, whereas keeping them in joint names will usually protect them. Although each situation must be carefully considered, we believe that for many the substantial tax savings associated with the use of a credit shelter/family trust are worth serious consideration.
As a result of the increase in the exemption amount in the new tax law, we recommend that all wills be reviewed to make sure that the terms are not written in language which places "$600,000.00 in trust." If it does then the estate plan may fail to take full advantage of the increasing exemption. Other wills which do not specifically leave "$600,000.00 in trust" may be written in terms of a "credit shelter" portion. Since the "credit shelter" portion is increasing (up to $1 million by the year 2006), this may take money out of the hands of the surviving spouse and family members which in effect may disinherit those individuals who were the intended recipients of that property. In that regard, it may make sense to retitle assets to make sure surviving spouses hold enough property in their own name to sustain their desired lifestyle.