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November 8, 2003: No Worries About Estate Taxes?

Q: I do not have to worry about estate taxes for three reasons: I do not have enough taxable assets to have exposure; the recent tax law changes have eliminated "death taxes;" and the law will be adjusted so we never have to worry about them coming back in the future. Right?

A: Not!! OR as my six-year-old friend next door might say – no way, Jose!!

First, I am told that there may be as many as four million millionaires in the Unites States (as the estate tax collectors calculate one’s worth) and if the combined net worth of a couple is lumped together, I suspect the figure is much, much higher. A million dollars of tax value adds up quickly. Thus, many people are surprised when their taxable estate is calculated and they appear on the tax radar screen. At least it is better to know about this potential liability ahead of time so adjustments can be made to minimize or to eliminate exposure. Otherwise, 48% (both state and federal) of the excess over the exemption will be taken.

Remember everything owned by the deceased and passed on at death is included in determining a taxable estate, even the face amount of life insurance, retirement proceeds, etc. As once pointed out by a Hawaii estate planning attorney friend, the taxable asset list would also include your bird, the bird cage, and the paper on the bird cage floor.

This year, one person can pass on $1,000,000 of value tax free. Next year (in less than two months), the amount increases to $1,500,000. In addition to this deduction that each of us has, one spouse can pass on any amount to the other spouse. Therefore, Bill Gates can pass on his forty-eight billion dollars to his spouse without taxes.

The normal estate plan passes everything directly to the surviving spouse, which means there is no tax at the first death since one spouse can pass on everything tax free, but then all the assets are piled up and exposed at the second death (where only $1,000,000 can pass on tax free this year). For Mrs. Gates, this means a taxable estate of forty-eight billion dollars and an estate tax exemption of only one million dollars if she should subsequently die.

Tax estate planning uses the first spouse’s exemption to divert assets away from the surviving spouse’s direct ownership or control. Thus, at the first death, instead of leaving everything to the surviving spouse, the exemption amount can be left to say the children, friends, "your favorite attorney," etc. But normally the amount, up to the exemption, is set aside in a trust so the assets can be returned to the surviving spouse as needed, or the trust can be terminated and assets distributed back to the spouse if there is no longer a need, such as estate taxes having been eliminated. The cost for a tax-trust Will is about $500 for each Will.

Now this tax trust is not the same as a living trust. It is a separate trust that is put inside a Will or "inside" the living trust to receive the funds diverted to it.

The tax reform act increases the exemption to $2,000,000 in 2006 and then $3,500,000 in 2009, until in 2010 all taxes are eliminated. (Bill Gates, if he died in 2010, could leave forty-eight billion to his two little children tax free.) But in 2011, the tax is re-imposed for any value over $600,000. (The figure $1,000,000 is commonly used, but I am assured that $600,000 is the true figure.)

Thus couples with tax exposure need to consider doing tax wills, even if that exposure may be eliminated in the next few years because of the increasing exemption. And for defensive reasons, many couples are keeping their tax wills or are doing tax wills if their combined net worth could be above $600,000 ($1,000,000) in 2011 and one of them might pass away in the next seven years and the other spouse survives after 2010. Remember unless assets are shifted at the first death, we lose the opportunity and flexibility that this preplanned move gives the couple to divert value away from the survivor’s taxable value, but leaves the flexibility in place to adjust the plan if, after the first death, the tax trust is no longer needed or the law changes. But in the meantime, the diverted assets are on the non-taxable side of the street.

But the long and short of it is that many more of us need to be realistic about estate tax exposure because the tax collector certainly will be. But normally with a little relatively inexpensive planning, we have the power to cause death to "death taxes" regardless of what the current crop of politicians in control might do.

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