Unless Congress enacts new estate tax legislation before December 31, the federal estate tax – which under the Bush 2001 tax laws was repealed for 2010 – will return with a vengeance in 2011. Beginning January 1, estates for deceased individuals will be taxed at a rate of 55% for assets in excess of $1 million that pass to anyone other than a spouse. Assets that pass to a spouse – either outright or in a qualified “marital deduction trust” – will qualify for the same “unlimited marital deduction” that existed under prior law.
The impact of a $1 million estate tax exemption will be dramatic for many estates. For example, assume a widow residing in New York dies on December 31, 2010 with a $5 million taxable estate. Her estate would be subject to payment of New York state estate tax of $391,600, leaving $4,608,400 to go to the widow’s heirs. If she were to die on January 1, 2011, however, the total federal and New York state estate tax obligation would jump to $2,045,000, leaving $2,955,000 for the heirs.
If the $1 million estate tax exemption in fact returns in 2011, here are a few key planning ideas for consideration:
- For married couples, your wills and/or living trusts should include estate tax planning clauses that allocate the maximum exemption amount to a “credit shelter trust” after the first spouse’s death. This relatively simple strategy will ensure that each spouse will be able to use their respective $1 million exemption – thereby sheltering a full $2 million from federal and New York state estate tax. One caveat is that each spouse (or their respective living trust) must individually own assets that will be made available for funding into the credit shelter trust after the first spouse’s death. If assets are owned jointly between spouses, the tax planning clauses will be rendered useless, since the jointly owned assets will pass automatically to the surviving spouse.
- For larger estates, life insurance held in an “irrevocable life insurance trust” will, in most cases, pass to the heirs exempt from both estate taxes and income taxes. Life insurance held in this type of trust is especially helpful if a majority of your assets are illiquid, such as real estate or business interests.
- Couples (both married and unmarried) can use “spousal gifting trusts” that allow for the transfer of assets to each other that will be exempt from estate taxation in either partner’s estate.
- Consider making annual gifts up to the exemption amount (currently $13,000 per year) to children, grandchildren or other desired beneficiaries. Note that neither qualified medical expenses nor educational expenses (e.g., college or private school tuition) are subject to the $13,000 annual cap.
Rarely in our nation’s history have we faced such a dramatic change in our estate tax law. Given the ever-changing landscape, you’re well advised to seek competent professional advice to update your estate plan to ensure that both your tax and non-tax planning objectives are satisfied.