James M. Spicuzza - The Trust Group - Estate Planning, Annuities, Life and Health Insurance

The Estate Tax is a tax on your right to transfer property at your death.

FEDERAL ESTATE TAXES

Federal Estate Taxes are a real thing. We often joke that it's taxation without respiration; however, it's no laughing matter.

If you think you're not wealthy enough... Think again. The taxable estate includes "EVERYTHING" including life insurance.

Think about it. For example, you own a home worth $300,000. Another vacation home or a small business worth $200,000. Between you and your spouse you have IRAs, 401(k), Bank CDs and Annuities totaling another $500,000. Then maybe you have a life insurance policy worth $1,000,000. The person in this example has Federal Estate Tax problems.

Federal Estate Transfer Taxes are due 9 months after the date of death. A portion of the taxable estate is exempt.

The schedule goes as follows:

It's expected that congress will sunset the Bush tax cuts and keep the exemption at $1,000,000 per person.

What is included in the Estate?

The Gross Estate of the decedent consists of an accounting of everything you own or have certain interests in at the date of death. The fair market value of these items is used, not necessarily what you paid for them or what their values were when you acquired them. The total of all of these items is your "Gross Estate." The includible property may consist of cash and securities, real estate, insurance, trusts, annuities, business interests and other assets. Keep in mind that the Gross Estate will likely include non-probate as well as probate property.

What is "Fair Market Value?"

Fair Market Value is defined as: "The fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts. The fair market value of a particular item of property includible in the decedent gross estate is not to be determined by a forced sale price. Nor is the fair market value of an item of property to be determined by the sale price of the item in a market other than that in which such item is most commonly sold to the public, taking into account the location of the item wherever appropriate." Regulation §20.2031-1.

So what does this mean for you?

Here's an example:

Husband and wife have an estate valued at $2,000,000. Husband dies in 2010. There's an unlimited martial deduction between spouses. However, because he died, his exemption died with him. So instead of having a total of $2,000,000 in exemptions, there is only one for the surviving spouse.

Now, come 2011 the surviving wife dies. That means $1,000,000 is exempt, but because the estate exceeds the exemption, the transfer of the estate to the beneficiaries will be taxed at 44% or $435,000 due and payable to the Department of the Treasury 9 months from the date of death.

A big mistake.

So, what can you do to avoid, minimize or mitigate this?

First of all, you cannot do this after the fact. Once it happens there is no going back.

There are two things you can do. If you're a married couple you setup an AB or Bypass Trust. This type of trust allows you to keep both exemptions intact even after the first spouse dies. In other words, in the above example there would be no estate taxes due because of the AB Trust. The estate would be split between both the A Trust and the B Trust. For example $1,000,000 in the A and $1,000,000 in the B. This must stay this way at all times even after the first spouse to die. The surviving spouse may take income or invade principal for care, comfort, maintenance and support. Now, when the second spouse dies both trusts pay out to the named beneficiary Federal Estate Tax Free utilizing both exemptions.

If your estate exceeds the benefits of having an AB Trust, then coupled with the AB Trust you can setup an Irrevocable Life Insurance Trust.

For example, if you have a gross estate of say $10,000,000 and the surviving spouse died in 2011. The AB Trust would exempt $2,000,000. However, the remaining $8,000,000 taxed at 46% would be a total tax due of $3,695,000 due and payable 9 months after death. So, you purchase a life insurance policy to pay the tax, in this example $3,695,000. You are essentially paying the tax with discounted dollars. Between spouses the least expensive form would be a "second to die" policy. Basically, two people are insured under one policy and the death benefit is paid out on the "second spouse to die." Yet, because life insurance is part of the estate when calculating federal estate taxes the Irrevocable Trust must own the policy. If you own the policy you would be increasing the taxable estate by $3,695,000. In other words, now the gross value would be $13,695,000 and the taxable value would be $11,695,000 increasing the tax due to $7,012,000. A big mistake.

This is a very complicated area of Estate Planning, if you believe you have Federal Estate Tax problems and would like more information please contact us for a free consultation.

Disclaimer: The Trust Group does not practice law. The Trust Group has relationships with properly licensed Florida attorneys. Any legal documents to be prepared or modified is done solely by attorneys properly licensed in the state of Florida.