Estate Planning Saves Money

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With the changes in estate tax laws promulgated by Congress in 2001, legislators have created the ultimate concept in estate planning. Under these rules, the estate of a taxpayer who dies in 2010 is completely exempt from tax (although a gift tax may be due, the estate tax is eliminated). That’s right; an estate of any size is completely exempt from taxation if the taxpayer passes away during calendar year 2010. The word is wealthy – but not so healthy – U.S. taxpayers are already inquiring about the availability of euthanasia in European countries just to ensure their demise coincides with that narrow window of opportunity. Those feeling like they might not make it five more years are trying to hold on.

Why such ridiculous circumstances? Although it is impossible to guess the will of Congress, it is no secret that many legislators have been opposed to estate taxation for years. Despite opposition from factions who see elimination of the estate tax as a benefit primarily available to the rich, most charitable, non-profit organizations are opposed to lifting estate taxes as well. All wealthy people have gifting strategies to lower their taxable estates. Without this need to lessen the burden of taxation on estates, directors of non-profits reason, there is little incentive for donors to pony up for good causes. Most wealthy people make donations because their accountants tell them to, not because they want to make the world a better place. If the estate tax disappears, along with it goes the incentive for a lion’s share of planned giving in this country.

But why 2010? Those in favor of eliminating estate tax assuaged the concerns of the opposition by proposing a gradual, 10-year transition, to measure the effect of less revenue from taxable estates. This transition culminates in a single year when the tax is zero. The law also has a built-in >sunset’ provision that reverses the changes put into effect with the 2001 law if Congress does not act to retain them. Supporters of eliminating estate taxes are gambling that the Congress seated in 2010 will not reverse changes passed in 2001, probably reasoning that no elected official wants to be associated with an increase in taxes.

Only a very small percentage of U.S. taxpayers actually end up paying an estate tax, but with rates that begin at 45 cents on the dollar, a substantial amount of revenue is raised from a small number of taxpayers. If the U.S. is still plagued with a growing deficit in 2010, all bets are off. The prospect of raising revenue with a tax that affects only a minority will look appealing to most voters.

Congress is not known for reversing earlier decisions, especially when those decisions were generally popular. But creating a situation where people are planning to die by euthanasia to avoid estate taxation is morbid and outrageous. And, since the estate tax really only affects relatively few taxpayers (most of whom are also fabulously wealthy), it is not entirely unlikely that the estate tax will be back in some form in 2011. The one segment of society often hurt by estate taxes is the ‘cash poor, land rich.’ Most are farm and forest owning families that do not realize the fair market value of their land is often high enough, when coupled with the decedent’s other assets, to trigger a tax.

There is also a cruel irony that the due-date on estate taxes is equal to the human gestation period: nine months after the decedent passes away, taxes must be settled unless the family requests an extension. Even a taxable estate (after applying the Unified Gift and Estate Tax credit, described below) of $100,000 in 2007 leaves the family with a $45,000 tax bill, which is more cash than most people keep on hand. Families facing such a tax often sell timber or land, usually to a highest bidder who does not have farm or forest values in mind. Forcing farm and forest owning families to parcelize land to settle an estate is an absurd policy and completely unnecessary. Most families can easily and cheaply avoid estate taxation with just a little extra planning. In other words, don’t depend on Congress to eliminate estate taxes in 2011.

Unified Gift and Estate Tax Exemption
Year Exemption Amount
2006 $2.0 million 
2007 $2.0 
2008 $2.0
2009 $3.5 
2010 No Estate Tax (Gifts are still taxed) – Exemptions are irrelevant
2011 Quite Possibly: $1.0 million – plus effects of inflation since 2001 (unless sunsetted by Congres) 

Current rules allow a taxpayer to shelter otherwise taxable gifts plus the final estate with a ‘credit’ that for most taxpayers covers the tax due on the sum of taxable gifts and the estate. In 2007 and 2008, for example, the exemption is $2.0 million. The exemption jumps to $3.5 million in 2009, and in 2010 the estate tax is eliminate, but for one year only (and just the estate tax, not taxes on gifts). In 2011 – if the current law is not sunsetted – the rules revert back to those of the Taxpayer Relief Act of 1997. If this happens, the exemption plummets to $1 million per taxpayer plus adjustments for inflation.

Under either law, spouses can inherit an estate of unlimited value, tax free (or, realistically, tax deferred). Such has always been the case and this rule has fueled many of the problems forest and farm families experience today. After all, there is little incentive to do estate planning if one or the other spouse can die without being taxed. But when the surviving spouse passes, the Unified Gift and Estate Tax rules apply and the effects on survivors can be devastating. With just a little planning and a relatively minor expense, most farm and forest families can pass an estate to their heirs completely free of estate tax. The opportunity to do so arise from IRS rules that view a husband and wife as separate taxpayers. Here’s how it works:

A married – or civil union – couple develop a revocable trust agreement in two parts, one in the name of each spouse. They then divide their property interests roughly down the middle and retitle assets to the two trusts. This allows the family to take advantage of two exemptions rather than one, effectively sheltering twice the amount they are able to shelter without using a ‘unified credit trust’ (also known as an A/B trust).

A ‘trust’ is a separation of legal and beneficial interests in property. In a unified credit trust, the legal and beneficial interests are separated for tax purposes, but the trustees are also the beneficiaries until they die. Since a trust is considered a contractual relationship, another advantage of placing one’s assets into trusts is that it avoids the cost and hassle of probate.

When one spouse passes away, the Unified Gift and Estate Tax exemption available that year (see table) shelters the trust of that spouse. But here’s the best part: the decedent’s trust—both the assets and income from the trust—is available to the surviving spouse. When the surviving spouse passes, the exemption available that year shelters the other trust. Confused? Here’s an example for a couple without a trust, followed by the same example covered with a Unified Credit Trust.

A husband and wife purchased 1,000 acres of forest land in 1953 for $300,000. In 2007, the land is worth $1.5 million (due to development pressures from a nearby ski area). Combined with other assets their total estate in 2007 is valued at $2.3 million. These numbers may sound outrageous, but it doesn’t take much development pressure to inflate real estate values.

The wife dies in 2007 leaving the entire estate to her husband who inherits it tax-free. In 2008, when the total estate is worth $2.5 million, the husband passes away leaving the land and other assets to his children. The 2008 taxable estate is figured as follows: Total estate value minus the exemption available under the current Unified Gift and Estate tax rules. In this case, it is $2.5 million minus a $2.0 million exemption (in 2007), resulting in a taxable estate of $500,000 and an estate tax of $245,000. If the husband had died a year later in 2009, a $3.5 million exemption available that year would have sheltered the entire estate.

Families with cash and other assets that are easily liquidated can pay the estate tax without having to sell land or timber. But more often than not, families must sell timber or land to settle with the IRS and to divide the estate among heirs. The result: parcelization of forest land and fragmentation of purpose, a tragedy that could have been easily – and cheaply – avoided with an A/B Trust.

Consider the same couple, same land, same values, but in this case they decide to create an ‘A/B Trust’ in early 2007, placing half the value of their assets in a trust under the wife’s name, and the other half in a trust under the husband’s name. The wife dies in late 2007 and approximately half of their total estate ($1.15 million) is sheltered by the exemption available that year – $2 million. The husband can use income from his wife’s trust, or the assets themselves, while he is alive. Or, the wife’s trust can be disbursed to her heirs (as intact, well-managed forest land!); the choice is up to the couple at the time they set up the trusts.

When the husband dies in 2008 his trust is sheltered with the $2.0 million exemption available that year. If his trust encompasses about half the total estate, it has about $1.25 million of assets in it and this amount is fully sheltered by the $2 million exemption. The result: no estate taxes are due! The same family without an A/B Trust pays $245,000 in estate taxes.

At workshops on estate planning for woodland families, participants are always amazed and more than a little incredulous about setting up an A/B Trust. After all, AIf it’s too good to be true, it probably is.” The accounting also has an air of impropriety, and people are reluctant to risk their fortunes on what appears to be an unbelievable tax shelter. But the A/B Trust is a perfectly legal and valid strategy to protect assets from estate taxation.

The cost of setting up this type of trust depends on the circumstances, but most families can expect to pay $1,500 to $3,000 for legal assistance. Fees are lowered by helping the attorney do some of the leg work, such as re-titling assets. Although this may seem like a lot of money, an A/B Trust can also save $5,000 - $15,000 in probate expenses, and tens of thousands of dollars in estate taxes assuming, that is, the owners are not planning a European death-pact in 2010.