Estate Tax Planning

Estate Tax is the tax imposed by the Federal government and some State governments (not Florida) on the value of your Estate when you die. Your estate is basically the property you own, with some deductions/credits for debts, charitable deductions, and costs for settling your estate.

Although most people will not owe estate tax based on the current tax laws, laws can change, especially the estate tax "exemption" amount, which is a controlling factor usually in deciding when estate taxes are owed. There are some planning options you can build into your estate plan to help protect against changes. If you want to skip ahead to the section discussing implications of changes to estate tax laws, it is towards the bottom of the page, but the discussions above that provide some context, and also a discussion of some estate tax concepts and planning options.

For many people all of the below will be more clear if we go through it sitting down together (or via video conference while we're facing Covid), versus reading through a discussion of tax rules. I include the information here for anyone who would like to read on.

The estate tax rate ranges from 18% to 40% depending on the value of the estate, but each person currently has an $11.58 million estate tax exemption. Which means for a single person, if your estate is worth less than that amount there is no estate tax owed. For the value of assets of the estate over the exemption amount, the highest 40% tax rate is applicable. There is an additional, special kind of estate tax called a generation skipping transfer tax (GSTT), imposed basically when you leave a gift that skips a generation, and there is the same current exemption amount for that type of tax also.

One important item - the amount of the death benefit from a life insurance policy insuring your life is included in the value of your estate if you are the "owner" of the policy - you are the owner if you are the person with the contract rights under the policy to name beneficiaries, borrow against the policy etc. This factor is the reason some people with large estates will have their life insurance policy owned by an irrevocable trust, so that the policy amount is not included in their estate and subject to estate tax.

For married couples, when all of a couple's assets go to the surviving spouse or the surviving spouse's revocable trust, they are all exempt and protected from estate tax by what's called the unlimited marital deduction, if the surviving spouse is a U.S. citizen. There is thus no estate tax when the first spouse dies (there is a special type of trust which can be used if the spouse is not a U.S. citizen). For example, if a couple has assets worth $20 million, they can all pass to the surviving spouse estate tax free. When the surviving spouse passes away, however, his or her assets, assuming no change in value or the exemption amount, would be $20 million, which is greater than the $11.58 million exemption amount.

There is something, though, called "portability", which allows a surviving spouse to receive any unused portion of the deceased spouse's exemption, if certain rules are followed at the time of deceased spouse's death, including filing an estate tax return and making a required election/choice to use portability. If portability was properly elected, the surviving spouse in our example here, at the time of her or her death, could have his or her $11.58 million exemption, plus the $11.58 million exemption of the first spouse, and the full $20 million could be protected.

As another option, rather than having all of a couple's assets pass directly to the surviving spouse, or to a revocable trust for the surviving spouse, half could go into a separate irrevocable trust we call a credit-bypass or Family Trust, with the amounts in that trust available for use by the surviving spouse during his or her lifetime, and then passing, for example, to the couple's children when the surviving spouse's dies.

In our $20 million example, if half, $10 million goes to the Family Trust, this amount is included in the deceased spouse's estate, but exempt from being taxed because it is less than the $11.58 million exemption amount. The amount in this irrevocable trust is not included in the estate of the surviving spouse when the surviving spouse dies. So, when the surviving spouse dies with an estate of $10 million and exemption of $11.58 million (assuming no change in value or exemption amount) the full $10 million is protected.

There can be tax and non-tax reasons why either portability or use of a Family Trust is better in each situation, including concerns some people have that an estate could lose the portability option by failing to properly make an election or file an estate tax return. However, with some straightforward planning it is possible to give the surviving spouse the option when the first spouse dies, to either to choose to make use of portability or a Family Trust or not, based on consultations with tax and financial planning advisors.

One variable or scenario that can go into this decision, using again our $20 million dollar scenario, is that if all of the assets go to the surviving spouse at the time the first spouse dies, but then over the years increase in value to $30 million, portability will not be enough to protect all of the assets. $6.84 million of the $30 million would be subject to estate tax ($30 million -- $23.16 million combined exemption). However, if half of the $20 million went into the Family Trust and was exempt at the time of the first spouse's death, and the surviving spouse's $10 million increases in value to $15 million, the assets subject to estate tax would be $3.42 million ($15 million -- $11.58 million exemption; the assets of the irrevocable Family Trust are not included in the surviving spouse's estate when the surviving spouse dies). Basically, the Family Trust protected half of the assets from estate tax arising from increase in value. Or conceivably, the assets which tend to increase in value could have been placed in the Family Trust possibly protecting more than half, or all of the increase in value.

Estate tax is not the only type of tax people worry about. There is also capital gain or income tax on assets when they're sold if they've increased in value. Sometimes an estate will want particular assets included in the surviving spouse's estate (i.e. not placed in the Family Trust) because they receive a "step-up" in "basis" at that time (more on this below). Portability can be lost in some circumstances when the surviving spouse remarries; a portability election can cause loss of a GSTT exemption; and as discussed in Life and Estate Planning, there can be important non-tax reasons to choose a Family Trust.

The point of this part of the discussion is not to suggest that the choice is impossibly complex, but rather to highlight again that it is possible to give the surviving spouse the option to decide at the time of the first spouse's death which approach to choose based on the facts then, and this option of providing flexibility will be best for many couples.

Currently, most families will not be over the $11.58 million exemption amount let alone the combined $23.16 million amount, so there may seem to be no reason to build in any estate tax planning. The exemption amount, however, was $5 million in 2011, $3.5 million in 2009, and $1 million in 2002. Periodically, there are proposals to change the estate tax rules, and conceivably a change could be made that would create estate tax liabilities for more families.

If the estate tax exemption was reduced to $3.5 million, or $1 million, many more families could potentially be subject to estate taxes. For example, if you include the value of a home that is paid off, some retirement and investment accounts, with an exemption amount change there could be potential estate taxes for more families.

Because incorporating options to take advantage of both spouses' exemption amounts is not overly complicated, and can include flexibility as discussed, it can make a lot of sense to build in this flexible tax planning, just in case the estate tax laws change. In addition, using the irrevocable trust can provide some special asset protection for the surviving spouse and children, which can be an even more important reason sometimes to use these planning options.

If we meet, we will walk through the options step-by-step, in what I think will be an easy to understand process. Most likely the decisions we arrive at for each option will be fairly clear for you, but there is also an opportunity to sit with the decisions for some time. If anything ends up not feeling right, we will have time to make changes.

Another important estate tax concept is the increase in "basis" of property that is included in a decedent's estate. The information below will go into a little more detail, but the basic factor to take away here is that sometimes there can be income tax reasons, based on which assets have appreciated or tend to appreciate in value, to give assets directly to a surviving spouse, or put into a special type of trust called a QTIP (Qualified Terminable Interest Property) Trust; and that the same planning options which give a surviving spouse flexibility to decide how much property to put into a separate, irrevocable Family Trust, can also be used to decide which property to put where.

When these decisions are important at the time of the first spouse's death, they'll usually be made with the input of a tax or financial planning advisor, and it is not difficult to build into your estate plan the flexibility for the surviving spouse to make the choices with the assistance of those advisors.

Basis can be considered basically your cost to purchase an asset, or it's purchase price, with later adjustments made under the IRS statutes and rules. If your purchase price and basis for some stock is $100,000, and the stock increases in value to $150,000, there will be $50,000 subject to tax if the stock is sold for $150,000. When an asset is included in a person's estate, it receives a "step-up" (another term for increase) in basis to current fair market value.

So, if a spouse dies, has assets with a basis of $100,000 and current fair market value of $200,000, the assets receive a step-up in basis to $200,000 if they go into the Family Trust at the time of death. However, the assets in the Family Trust will not be part of the surviving spouse's estate, and will not receive a step-up in basis when the surviving spouse dies (when the assets go into the irrevocable trust when the first spouse dies, they are owned by the trust, and not owned by the surviving spouse, and therefore not included in the surviving spouse's estate). If the assets have increased in value from $200,000 to $400,000 by the time the surviving spouse dies, and these assets go to the couple's children at that time, the children could potentially face tax liabilities if the assets are sold.

Here again, there are planning options which give the surviving spouse the choice of which assets to put in the Family Trust, and which to receive outright or put in a different type of trust, which will be included in the surviving spouse's estate and receive a basis step-up when the surviving spouse dies.

Call be at (954) 636-7498, or use the Contact form on the website, and we can discuss the estate tax issues relevant for your Life & Estate Planning.