Contents Section Goals 1 Estate Rules and Considerations 2 Annual Gift Tax Exclusion 3 Stepped Up Basis 4 Estate Transfer Documents 5 Substitute for Wills
6 7 8 9 10 11 12
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14 15 16 17 18 19 Durable Power of Attorney 20 Health Care Directive 21
To insure that one’s property is managed and ultimately disposed of as the owner wishes.
A proper estate plan should eliminate or minimize estate taxes.
A proper estate plan should carefully consider both the non-tax costs, the administrative burden associated with implementing the plan, the time involved and the personal responsibility to fulfill the plan.
A proper estate plan should insure that minor children are raised by those who their parents appoint, in the event of the their untimely death, and that the assets allocated to the children are managed in a manner and by a person of the parents’ choosing - rather than leaving it to a court to decide.
Estate Tax Rule and Considerations
There are no estate taxes, or state death taxes, unless one’s net estate exceeds $650,000. This exclusion amount is schedule to increase in increments by the year 2006 to one million dollars.
Estate tax rates start at 37% , by the year 2006 they start at 41% and rise to 50%. Thus, a decedent who dies in the year 1999 and has a net estate of one million dollars, is subject to an estate tax of $129,500 ($1,000,000 - $650,000 = $350,000. $350,000 x 37% = $129,500).
A decedent’s estate receives a deduction for all property left to the surviving spouse. Thus, no matter what one’s net worth might be, if all property is left outright to the surviving spouse there would be estate tax upon the first death. The problem is that the property left to the spouse would then be taxed upon her death to the extent her net worth exceeded the exclusion level.
The estate tax limitation goal of any proper plan is to take advantage of the marital deduction coupled with the exclusion amount (also referred to as the unified credit) in order to avoid estate taxes at the first death, and avoid taxes at the second death unless the combined net worth of the couple exceeds two million dollars (by the year 2006).
What is considered one’s taxable estate? One’s taxable estate includes one-half the value of the community property and any separate property acquired by a decedent either before or during marriage. One’s taxable estate includes life insurance proceeds paid on account of the decedent’s death or, 50% of the cash surrender value of life insurance on the surviving spouse’s life.
One’s taxable estate also includes one-half of the community property portion of retirement accounts. For example, if a decedent is the unemployed spouse, his or her estate nevertheless includes 50% of the accumulated value of the retirement of the working surviving spouse.
Whether property is included within one’s taxable estate is not controlled by the method by which the property is transferred or not transferred at death.
One may gift $10,000 a year to as many recipients as you wish. So, a married couple could give $20,000 a year to each child gift tax free and thereby reduce their estate and, or perhaps slow the growth of their estate, in order to eliminate or avoid estate taxes at death.
In considering a gift program, one must compare the estate tax consequences with the income tax liability upon a sale of appreciated property. Both halves of the community property receive a stepped up basis to date of death value at the time the first spouse dies. So, if one owns an apartment house that is worth $200,000 at death and it has been depreciated to where its tax basis is $50,000, a sale before death would result in a $150,000 gain subject to income tax. However, if this property were sold after the first spouse dies, one half of its value would be included in the decedent's estate but the entire asset would receive a "stepped up" basis. The income tax on gain would be avoided. When one gifts property, the recipient receives the tax basis of the donor. Thus, to the extent that one gifts appreciated real estate to their children, while it takes property out of the estate and eliminates the estate tax liability, the done receives it at a lower basis, and thus is subject to income tax liability should he or she sell it for more than what its tax basis was in the hands of the donor.
In general, income tax rates are substantially lower than estate tax rates and therefore while this is an important matter to consider, it still may be prudent to gift appreciated real estate even though the recipient will lose the "stepped up" basis that he or she would obtain by means of inheritance rather than a gift. For example, assume you own an apartment house that is worth $150,000 and has a tax basis today is $50,000. If both parents were to die and their children were to inherit that apartment house, they could sell it for $150,000 and avoid any income tax. However, it would be included in your estate subject to estate taxes. Now, if one parents were to gradually gift that apartment house to the children by means of the annual exclusion, the children would have a lower basis and thus income tax liability should they sell it, but that income tax liability would undoubtedly be less than the estate tax liability if they were to receive it by means of inheritance.
Another example. If one purchases a share of Pepsi stock at $30 and thereafter sells it at $50, he has $20 of gain subject to income tax. If gifts the share of stock and the recipient sells it, he too has the same gain. But if one dies, the stock is valued to determine the amount of the decedent’s taxable estate. And the estate assets, including the stock, receive a stepped up basis to date of death value. Thereafter, whoever inherits that share of stock could sell it at $50 and have no income tax liability.
Particularly for parents with young children, we feel a will is necessary so that one may appoint a guardian. For many people, much of their property may be transferred at death without regard to a will. For example:
Joint Tenancy with Right of Survivorship. If one registers a bank account or a brokerage account containing various investments in the form of joint tenancy with right of survivorship, the assets in said account pass to the surviving joint tenant at the first death.
Beneficiary Designations. Not only does life insurance pass to the named beneficiary (so long as there is no violation of the surviving spouse’s community property rights) so too may retirement accounts be left outright to a named beneficiary rather than having their disposition controlled by one’s will.
Trusts. Property may be transferred in trust to a named trustee, who may be the grantor of the trust. The trust may include instructions for the transfer of the property upon the death of the grantor. These arrangements are sometimes referred to as living trusts. We often utilize trusts for older clients, particularly clients who own real estate in another state. If one transfers all of one’s property into a revocable trust, and diligently manages to take title to all future acquisitions in the name of the trust, the use of the trust may avoid the administrative expense involved in probating a will. This may well be a benefit for an older client who would not have to incur the expense in both time and money in managing such a trust for many years.
In general, we don’t feel that revocable living trusts are an appropriate estate planning tool for younger married couples. The cost of preparing a trust is two to three times that of preparing a will and the cost in both time and money in maintaining the trust continues on an annual basis. See related article, "Do You Really Need a Living Trust?"
And what is often not understood by clients who have heard about living trusts is that a properly drafted will has the same estate tax avoidance features as the trust. In other words, one does not avoid estate taxes by using a living trust instead of a will. The purpose of a living trust may be to avoid the expense of a probate - which expense has to be compared to the expense of both time and money in creating and managing the trust. See related article, "Comparisons of Taxes and Professional Fees Living Trust Trusts and Wills"
Care must be taken that arrangements set forth in substitute for wills are not in conflict with one’s will. For example, if one executes a will that provides all property at death shall pass the surviving spouse, yet names a child as the joint tenant on a bank account or beneficiary of a insurance policy, there would be a conflict between that designation and the wording in the will. And normally, these specific designations set forth in the substitute for the will would control.
In a will, the testator, the person whose will it is, determines who should receive his property, any limitation on the use of the property, how it should be disposed of, and if he or she has minor children, the testator may appoint a guardian to manage the assets of the minor heir and also have control over the child’s living arrangements.
If one’s net worth may exceed $650,000 or if a married couple’s net worth may exceed that figure, we usually consider providing for the option of a trust to be created at the time of the first death in order to maximize the possibility of estate tax avoidance. Essentially, one may consider leaving in trust up to the amount equal to the unified credit - currently $650,000. This will be included in the decedent’s estate, but because it does not exceed the limit there will be no estate taxes. The surviving spouse receives the income from said trust, the balance left in the trust at the death of the surviving spouse will not be included in his or her estate and will pass directly to the couple’s children.
Such a trust can be mandated, i.e., the decedent requires that his or her property be placed in the trust, this may be referred to as a credit shelter trust will, or, the decedent may leave the decision whether to utilize a trust to the surviving spouse who may at that time determine whether the use of a trust will help avoid taxes at the time of his or her death. This option is known as a disclaimer trust will.
Non-Trust Will
$900,000 Combined Net Worth
Husband Wife $450,000 $450,000 Husband dies first and leaves estate to wife $450,000 $450,000 $450,000 $900,000 Wife Dies -$650,000 Unified Credit $250,000 Taxable Estate 37%
Estate Tax Rate $ 92,500 Estate Taxes Summary
Husband dies first and leaves all property outright to wife.
No estate tax at time of husband's death because his estate is less than $650,000.
However, his children will pay $92,500 in estate taxes when mom dies.
A better solution - DISCLAIMER TRUST WILL.
Husband's will leaves to wife the option to disclaim a portion of the inheritance - place it in trust and receive the income. Upon her death trust assets distributed to their children.
-No estate taxes at second death
1. Simple "mom and pop" wills.
Each gives all assets to each other.
Can also use Community Property Agreement, joint tenancy with right of survivorship, or other nontestamentary method.
Caution: For estates larger than $650,000 the deceased would "give away" his/her estate tax exemption.
Give all assets to each other except those "disclaimed" (refused) by survivor after first death.
- The disclaimed assets are usually those in excess of $650,000 from the deceased spouse's estate.Disclaimed assets are held in trust for the lifetime benefit of the survivor.
- Disclaimed assets are not included in from the deceased spouse's estate.
- Disclaimed assets are added to the surviving spouse's estate.
- Survivor must receive income annually from disclaimed assets.
- Survivor may receive further distributions if allowed by trust.Caution: Surviving spouse may elect to take all assets and not "fund" the trust.
- Can result in higher estate taxes to survivor.
- Survivor can dispose of assets contrary to wishes of deceased.
Give assets in trust for lifetime benefit of survivor equal to value of estate tax exemption then in effect (e.g., $650,000 for 1999; etc.; up to $1,000,000 for 2006).
Assets are not included in survivor's estate.
Give balance of estate to spouse either directly or in marital deduction trust.
May better assure assets get to children.
Assets given by 1st spouse to die to benefit survivor for lifetime.
- Must pay income annually to qualify.
- Value is deduction from deceased's estate, but added to survivor's estate.
Do You Really Need a Living Trust?*
Despite the claims of the mass marketers of living trusts, the revocable living trust is not the estate planning tool of choice of most people. For a few people, it is a valuable estate planning tool, but for most, it is not worth the extra expense and record keeping.
The claim that living trusts save estate taxes is simply wrong. Any tax-savings device which can be incorporated into a living trust can just as easily be incorporated into a will, and wills have some minor tax advantages over living trusts. The claim that a living trust avoids probate is true, but misleading. For most residents of Washington, avoiding probate is simply not worth the effort.
Most of what must be done when a person dies (tax returns, collection and distribution of the decedent’s assets, payment of creditors, etc) must be done regardless of whether the decedent left a living trust or a will. If the decedent left a will, there must also be a probate.
Virtually all probates in Washington are "non-intervention" probates, which means that the court does not intervene. The court’s only involvement is to confirm the validity of the will and the appointment of the personal representative, both of which are usually accomplished in a five-minute proceeding that need not even be scheduled ahead of time. After that, a personal representative’s administration of an estate and a trustee’s administration of a living trust are virtually identical.
The cost of this minor proceeding is generally about the same as the extra cost of a living trust, but probate is an expense that need not be incurred until the time of death. Contrary to the claims many have made, the estate assets are not tied up by the court, and the time and expense necessary to administer the estate are no more than the time and expense necessary to administer a trust.
Living trusts do have their legitimate uses. A person owning real property in several states will want to consider a living trust, in order to avoid ancillary probates in each of the other states. A famous person may want to consider a living trust for privacy reasons, although very little about a person’s estate is a matter of public record when there is a probate. A couple wanting professional management of their affairs while they are alive or after the first spouse’s death also may want to consider a living trust. These are legitimate reasons for using a living trust; simply avoiding probate usually is not.
*Reprinted with permission of the author, Thomas Culbertson of Lukins & Annis, attorneys at law - Spokane
COMPARISONS OF TAXES AND PROFESSIONAL FEES
LIVING TRUSTS AND WILLS
Preparation
Will
Trust
Will with tax planning to eliminate or
minimize estate and inheritance taxesLiving Trust with tax planning to
eliminate or minimize estate taxesAll assets remain in the name of the owner All assets transfer to have the trust own the assets Cost $250 to $750
(Estimate - depending on complexity)Cost $1,500 to $5,000
(Estimate - depending on complexity)
Income Taxes
Income tax is the same whether the assets pass through a Probate or a Living Trust - unless a third person is the Trustee, in which event the taxes will probably remain the same but an extra income tax return will need to be prepared and filed.
Estate Taxes and Inheritance Taxes
Estate and Inheritance Taxes will be the same in a Living Trust or through a Will if both documents are planned to eliminate or minimize these taxes.
Costs After Death
Will
Trust
A Will must be probated. This consists of filing the Will with the Court and having
the Personal Representative appointed.
Cost Filing Fee $110 Atty's Fee $1,000(est.) A Trust does not need to be filed with the court nor does a representative need to be appointed. Cost $0
Administration After Death
(Work and Costs are Approximately the Same)Will
Trust
-Inventory and value assets
-Pay debts
-Prepare and file Estate and Inheritance
Tax Returns and pay taxes
-Prepare and file closing income tax returns
-Distribute assets to heirs-Inventory and value assets
-Pay debts
-Prepare and file Estate and Inheritance Tax Returns and pay taxes
-Prepare and file closing income tax returns
-Distribute assets to heirs
Privacy
Will
Trust
Will must be filed with the court. No
Inventory of Assets required to be filed for death after 12-31-97.Trust may or may not need to be filed with
County Auditor to clear title to land. No
Inventory of Assets required to be filed.
Trust may need to be presented to banks or title insurance companies (and others)
during lifetime to allow borrowing or transfers of title.
Speed of Distribution
Will
Trust
Distribution is possible before closure
of Estate but not recommended until after debts and taxes are determined. Premature distribution subjects
Personal Representative to personal liability.Distribution is possible shortly after death
but not recommended until after debts and taxes are determined. Premature distribution subjects Trustee to potential personal liability.
Litigation Potential for Wills and Trusts
Challenges can be made to the validity of either document for the same type of reasons such as incompetence, undue influence or mental illness. Litigation can also challenge interpretations, valuations and distributions for the same reasons for either type of documents.
More Estate Tax Considerations
Estate taxes based upon net value of estate, i.e., value less debts.
Traditional "fair market value" method used, i.e., "highest and best"
I.R.C. §2032A("Special Use Valuation")
- Small business/farms eligible.
- Reduce value to about 1/3 of fair market value.
- Strict requirements to qualify.
- Material participation by deceased/family before/after death.
- Assets stay in family for 10 years.
- Value of farm/business assets greater than 50% value of estate.
- Reduction limited to $750,000.
- Value becomes new basis for later sale.
- Recapture taxed if not stay qualified for 10 years.
I.R.C. §2033(new)
Small business/farm eligible
Excludes up to $1.3 million from estate taxes.
- Benefits reduce each year (e.g., exclude $675,000 in 1998 and only
$300,000 in 2006)
- Not indexed to inflation.
- Strict requirements (See §2032A).
- 50% test includes prior gifts to family.
Paid in full within 9 months of death.
I.R.C. §6166 allows deferral of taxes.
Small busniess/farms eligible.
15 - year payment plan subject to 2% interest.
Strict rules of eligibility.
The full home sale exclusion of up to $250,000 ($500,000 for qualified married taxpayers filing jointly).
Applies if the taxpayer(1) owned the home and used it as a principal residence for at least two of the five years before the sale and (2) had not previously used the exclusion within the two-year period ending on the sale date.
Whatever estate planning instruments are utilized, our goal is to maximize state taxation avoidance, and at the same time, implement a plan that does not create too expensive of a burden in terms of either management or administration.
There are other documents one might consider at the time they are reviewing their estate plan.
If a person becomes incompetent, a petition for guardianship may be filed with the county court and after a fairly expensive and lengthy process, a guardian may be appointed to manage the disabled person's affairs. A durable power of attorney prepared at a time before the principal becomes disabled avoids the need for a guardianship.
With a durable power of attorney one appoints a trusted person to manage his or her affairs, including the option to make health care decisions, should he or she become disabled. Usually, a durable power of attorney is effective at the time it is signed, but it is not sued unless the principal in fact becomes disabled.
By means of a health care directive people inform their family and physician whether they desire to be kept alive through artificial means should they have a terminal condition and be on life support systems.
