Plan Ahead

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Do you trust the government enough… to do your estate planning?

Lindsay Lohan in (and out of and back in) rehab, Charlie Sheen’s party life, the economy on the upswing, the economy on the downturn…

In light of all of these stories, it’s easy to overlook the significant changes in the federal estate tax law that were approved recently. Signed by President Obama on December 17, 2010, the Tax Relief, Unemployment Insurance Re-authorization and Job Creation Act of 2010 did not receive as much press as our movie stars, our new diet fads or the economy itself, which is tragic considering Americans are more affected by the act than they are by news of our movie stars and fashion trends.

The act extended many Bush-era tax rates, such as the capital gain/dividend rate at 15 percent and it continues our current federal income tax rates. It also provides some accelerated depreciation for small business owners. The estate tax changes, however, are probably the most dramatic change. The limited information read by Americans may lead them to believe estate planning is no longer necessary – and they would be deeply mistaken.

Why care about federal estate tax law?
Benjamin Franklin said, “In this world nothing can be said to be certain, except death and taxes.” Death is a certainty, although the time of death is not easily predicted. The tax law is ever-changing. Most people would prefer for their lifetime treasures and other accumulation to be distributed in the manner in which they want, not in a manner the local or federal government dictate. Additionally, would you prefer to give money to a lawyer or your children? How about the federal government or your niece? How about the state taxing authority or your best friend? Accomplishing the goal of disinheriting Uncle Sam requires planning and knowledge of the ever-changing tax arena.

A few terms every taxpayer should know about the federal estate tax…
Understanding a few key terms and well-established federal estate tax rules is imperative before diving into how the estate tax law changes affect individuals. Of course, this is not a comprehensive list of all rules and concepts surrounding estates and estate tax.

Rule #1: An individual may leave an unlimited amount of wealth to his or her spouse without any federal estate tax (called the marital exclusion).

Rule #2: The applicable exclusion amount is the total amount one can leave to their heirs without triggering the federal estate tax.

Rule #3: Remember that rule #2 does not include any amount given under rule #1. So, the applicable exclusion amount is in addition to anything given to the spouse.

Rule #4: The state death tax laws are different from the federal estate tax law. (If an estate is not taxable at the federal level, it does not mean the same estate is not subject to state death/estate tax.)

What was the law?
Under the former laws, the estate tax rate reduced over a period of years. Simultaneously, the applicable exclusion amount increased. For example, in 2008, the tax rate was 45 percent and the applicable exclusion was $2 million.

In 2010, the United States did not know what to expect. As a result, there was no estate tax for the year of 2010. (Estates of taxpayers deceased in 2010 now have a few options—one includes escaping estate tax, regardless of the estate’s size.)

What is the estate tax law now?
The act changed the federal tax treatment of estates in 2010 and offered an option. However, the option of $0 in estate tax still stands. For the years 2011-2012, the applicable exclusion amount is $5 million, and the maximum federal estate tax rate is 35 percent. In 2013, the applicable exclusion amount is scheduled to return to $1 million with the highest federal estate tax rate of 55 percent.

What will the law be?
No one has a crystal ball to predict if Congress will act before the year 2013 to keep the $5 million applicable exclusion amount. Some professionals feel the government will absolutely act before the $1 million exclusion hits in 2013. Others remind us few believed the year 2010 would hit, bringing us a year without federal estate tax at all! (These individuals believed Congress would act before the 2010 year to extend the federal estate tax.)

Even with the next few years “certain,” estate planning becomes more comprehensive with an ever-changing exclusion amount. Potentially, surviving spouses and other heirs could be left with decisions at the time of a loved one’s death. Estate planning aids by alleviating heirs of these decisions during a time of bereavement.

What is portability?
Under the act, portability was also created. Portability allows a surviving spouse to elect to utilize the unused portion of the applicable exclusion amount of his or her predeceased spouse. Portability, therefore, provides the surviving spouse with a larger applicable exclusion amount.

For example, if Homer passes away in 2011, and only leaves $1 million to his children, then Marge (his spouse) could elect to use the remaining $4 million toward her transfers at death, in addition to her applicable exclusion amount. If she passes in 2012, then her estate could transfer $9 million total without federal estate tax (her $5 million plus Homer’s unused $4 million), assuming Homer’s estate and Marge followed all the requirements of portability.

Before 2011, portability did not exist under the law, but rather could effectually exist through estate tax planning.

Why implement an estate plan with potential #10 million tax-free total per couple in 2011 through 2012?
Several motivations should push taxpayers to proactively plan for their estate, as opposed to allow the law to plan for them. A few examples of the downfalls of allowing the government to plan an estate follow.

First, portability is not automatic. A surviving spouse must elect to use the unused portion of their predeceased spouse’s exclusion amount. The estate of the decedent must file an estate tax return in a timely manner in order to allow the surviving spouse to take advantage of the unallocated portion. This means portability is not “automatic” upon the death of the first spouse. Rather, a grieving spouse must take a proactive measure by filing an estate tax return during a time of confusion and adjustment. Further, the estate may not have been otherwise required to file an estate tax return. Contrast this with having a comprehensive estate plan: In a well implemented plan, the surviving spouse would not have to take such affirmative action in order to retain the benefit of the unused exclusion amount.

Second, portability does not necessarily distribute property in accordance with the decedent’s wishes. A will and/or a trust should be published regarding how a person wants their assets distributed upon death. Absent a will or trust, property will be distributed in accordance to the intestate law of the state. (Many believe without a will or trust, courts will call witnesses to find out who Homer wanted to leave his beer can collection to after his death. But, the law is very strict and cold.) The portability concept has nothing to do with the distribution of assets, but rather the potential tax liability of an estate.

For example, say Lindsay Lohan and Charlie Sheen decided to marry and neither set up a will or a trust. In the year 2012, poor Charlie meets his maker after a weekend of “relaxation.” Does Lindsay now receive everything because of portability? No! Charlie’s assets will be distributed in accordance to California law. Roughly stated, Lindsay would receive about onethird of Charlie’s wealth, with the remainder going to his descendants. Because Charlie depended on what he believed to be “automatic” estate tax planning, his assets are going to be distributed in accordance to the law of California. He may have intended everything go to Lindsay or everything go to his children.

Thirdly, people who are betting the tax law will remain the same (exclusion amount of $5 million, portability, 35 percent max federal rate) must die by December 31, 2012, or their gamble won’t pay off! That’s when the law reverts back to a $1 million exclusion amount with a 55-percent federal estate tax rate. You must exit this world by December 31, 2012 for your estate to receive this benefit. Relying on a particular date for death is never a sound plan.

Finally, the increase in the federal applicable exclusion amount and the portability of this amount does nothing to minimize state-level estate and death taxes. State tax law is often different and independent from federal law. Therefore, what may not be taxable at the federal level could accrue tax at the state level. No matter where the tax/fees originate, paying funds to a taxing authority means less available for the heirs.

Estate planning reigns supreme
Who would want another person to determine how his or her lifetime accumulation was distributed? Who would want to create stress for a surviving spouse during a time of bereavement by requiring that person to make decision about the estate? Who would want to pay state taxing authorities instead of leaving wealth to heirs?

Estate planning provides flexibility and security to individuals and couples. A strong estate plan will consider changes in the federal and state law. Keep in mind that estate plans must also be maintained on a periodic basis—mainly whenever a substantial change in assets, intentions or tax law occurs. Finally, a benefit of a well-implemented estate plan is a safeguard in case the optimal maintenance of the estate plan has not occurred.

About Elizabeth Fullington 5 Articles
Elizabeth Fullington is the Business Development Manager for STA. She is a CPA and JD, obtaining her undergraduate degree from Truman State University in Kirksville, Missouri, and law degree from the DePaul University College of Law In addition, Elizabeth has her Certificate in Taxation form the DePaul University College of Law.

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