| What you Don't Know About Estate Tax Can Harm Your Heirs |
CALIFORNIA STATE INHERITANCE TAX.
At one time, California had a substantial inheritance tax. Surviving spouses sometimes found themselves selling their family residence in order to pay the inheritance tax on the deceased spouse's portion. Through a voter referendum, that tax was repealed and California no longer has any State Inheritance Taxes! Although the tax people were not very happy with the passage of that referendum, the widows and widowers of California have been much better off.
FEDERAL ESTATE TAXES
The Federal Estate Tax on decedent estates is among the highest and most confiscatory rates of any tax. Fortunately, (or unfortunately) most decedent estates are not large enough and do not have to pay any Federal Estate Tax at all. With the results of the current election and the substantial deficit and federal bail-out funding in the hundreds of billions, this tax is most likely the first place our legislators will look in order to raise additional revenue. Any estate plan MUST take into account the likelihood of a substantial decrease in the amount of the unified credit. The congress does not even have to change the tax rates, just the amount of exemption before an estate becomes taxable.
Below is an overview of the current tax rates and the amounts of unified credit exemptions.
In 2001, Congress passed The Economic Growth and Tax Relief Act of 2001. Under that law, the federal estate tax rates continued as before but they increased the Unified Credit and decreased the top federal estate tax rates.
WHAT IS THE UNIFIED CREDIT?
The Unified Credit is like the Personal Income Tax Exemption. The tax rate does not begin until the estate value exceeds the amount of the exemption. For example to determine the taxable amount of an estate worth $1,200,000 first the amount of the Unified Credit is deducted. If the Unified Credit is $1,000,000, then the amount of the taxable estate would be $200,000. If the Unified Credit is $2,000,000, then the amount of the Unified Credit would exceed the estate value and there would be no estate tax due.
If Congress REDUCES the amount of the Unified Credit, then the amount at which estate tax starts will be lower. Using our $1,200,000 estate value, and if the Unified Credit is reduced to say $500,000, then the same estate would be taxed on $700,000!
Back to Understanding Federal Estate Tax Rates.....
Stating in 2003, the amount of the Unified Credit was increased to $1,000,000 and in a series of steps further increased (thereby reducing the amount that is taxable in an estate) In 2010 the Unified Credit is scheduled to become unlimited, therefore entirely eliminating Federal Estate Tax for that year only. Then, in 2011, the exemption is scheduled to return to $1,000,000 and the top rate will return to taking an amazing 55% of the estates that people worked a lifetime to accumulate, and paid income taxes on the amount as well.
So, under the current laws, accountants and estate planning attorneys are recommending that their clients with potentially taxable estates die in the year 2010!!
If this whole area of Federal Estate Tax sounds crazy to you, you are not alone. Between the changes that we have been told WILL be taking place and the changes that MAY be coming about, Federal Estate Tax planning has become hitting a moving target; and not only a moving target, but one that may change at any time! The most sound approach to estate planning in the face of such uncertainty is to structure plans to maximize the use of the Unified Credit; whatever it may be in the future, or as my grandmother would say, "Hope for the best and prepare for the worst!"
ESTATE TAX RATES
AMOUNT OF TAXABLE ESTATE (AFTER DEDUCTION OF THE Unified CREDIT )
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FEDERAL ESTATE TAX ON ESTATE
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FROM
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TO
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AMOUNT OF TAX
PLUS THE PERCENTAGE ON THE AMOUNT OVER
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AMOUNT OVER
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$0
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$10,000
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18%
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$0
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10,001
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20,000
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1,800 + 20% on amount over.......
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$10,000
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20,001
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40,000
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3,800 + 22% on amount over.......
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$20,000
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40,001
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60,000
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8,200 + 24% on amount over.......
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$40,000
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60,001
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80,000
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13,000 + 26% on amount over.....
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$60,000
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80,001
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100,000
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18,200 + 28% on amount over.....
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$80,000
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100,001
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150,000
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23,800 + 30% on amount over....
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$100,000
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150,001
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250,000
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38,800 + 32% on amount over.....
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$150,000
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250,001
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500,000
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70,800 + 34% on amount over.....
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$250,000
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500,001
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750,000
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155,800 + 37% on amount over...
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$500,000
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750,001
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1,000,000
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248,300 + 39% on amount over...
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$750,000
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1,000,001
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1,250,000
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345,800 + 41% on amount over...
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$1,000,000
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1,250,001
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1,500,000
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448,300 + 43% on amount over...
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$1,250,000
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1,500,001
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2,000,000
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555,800 + 45% on amount over...
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$1,500,000
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2,000,001
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& Up
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780,800 + 48% on amount over...
(This is the Maximum Rate)
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$2,000,000
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UNIFIED CREDIT
YEAR OF DEATH
|
MAXIMUM
ESTATE TAX RATE
|
AMOUNT OF
UNIFIED TAX CREDIT
|
AMOUNT OF EXEMPTION
FROM ESTATE TAX
|
2003
|
49%
|
$345,800
|
$1,000,000
|
2004
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48%
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$555,800
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$1,500,000
|
2005
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47%
|
$555,800
|
$1,500,000
|
2006
|
46%
|
$780,800
|
$2,000,000
|
2007
|
45%
|
$780,800
|
$2,000,000
|
2008
|
45%
|
$780,800
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$2,000,000
|
2009
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45%
|
$1,455,800
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$3,500,000
|
2010
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0% ESTATE TAX RATE!
|
NONE
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NONE
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2011
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55%
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$345,800
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$1,000,000
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MORE ABOUT THE UNIFIED CREDIT...
Under the current law, each individual person's estate is given a Unified Credit (like a personal income tax deduction) and allowed to leave up to the amount of that Unified Credit, Federal Estate Tax free, to anyone they choose. Each dollar over the amount of the Unified Credit is taxed at the rate shown on the chart above. Simple, right? .....Not so fast!
California is a community property state in which each spouse owns one-half of their community property. It would then follow that a married couple with an estate of $2,000,000 and a Unified Credit of $1,000,000 should be able to leave their estate ($1,000,000 X 2 Unified Credits) = $2,000,000, federal estate tax free.
Unfortunately it is not that simple....
Sadly, most couples lose their individual exemptions because of a lack of estate planning. This lack of planning has brought the IRS billions of dollars in taxes that are unnecessarily paid. Without an estate plan that takes an affirmative step of claiming each individual spouse's Unified Credit deduction, the IRS will automatically impose the Unlimited Marital Deduction on the
deceased spouse's estate.
WHAT IS THE UNLIMITED MARITAL DEDUCTION?
Using the Unlimited Marital Deduction, a married person can leave any amount, even if it is over the amount of the Unified Credit, to a surviving spouse, without federal estate tax! Sounds great, right? The catch is that if you utilize (or are forced to utilize) the Unlimited Marital Deduction, you waive one of the spouses Unified Credit deduction. Upon the death of the second spouse, any estate value over the amount of the single Unified Credit will be taxable.
For a married couple with an estate worth $2 million, with a Unified Credit of $1,000,000 (as scheduled for 2011) the cost of using the Unlimited Marital Deduction rather than claiming the second Unified Credit, would be an incredible $345,000 in unnecessary tax! With proper estate planning, the amount of tax on that estate could be $0.
Federal Estate Tax must be paid within nine months from the date of death. Frequently real property must be liquidated at "fire sale prices" to pay that tax. As with other taxes levied by the IRS, there are substantial penalties and interest for late payment.
AVOIDING THE UNLIMITED MARITAL DEDUCTION.
If the Unified Credit changes to $1,000,000 in 2011, as it is scheduled, a properly drafted A/B living trust can allow a married couple to keep each of their individual Unified Credits against Federal Estate Tax, avoid the automatic imposition of the unlimited marital deduction and therefore allow up to $2,000,000 to pass free of Federal Estate Tax free!
This effective doubling of the Unified Credit for married couples applies to whatever the Unified Credit may be at the time of the death of the first spouse and can result in a HUGE tax saving.
HOW CAN A LIVING TRUST PROTECT BOTH SPOUSE'S UNIFIED CREDITS?
During the joint lifetimes of the spouses, all of the property is held in a single fully revocable living trust. Both spouses have total control over the estate and can use it in any way they see fit. The trust remains fully revocable or amendable. Upon the death of the first spouse, the property is then placed into two separate trusts, the "A" trust or Survivors Trust and the "B" trust or the Decedent's trust. The "A" trust remains fully revocable and amendable. The surviving spouse can then have complete access and use of the assets of both trusts for life. Upon the death of the second spouse, any remaining property can be distributed to the heirs they have chosen. By using this approach, the couple can avoid the imposition of the Unlimited Marital Deduction and the loss of the second Unified Credit.
This one simple estate planning strategy can result in a HUGE tax savings, thus demonstrating that estate planning does not cost, it saves!
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