
Introduction
Estate planning is more than the process of making sure
that your property will go to those you choose. It also involves continuing to
control your property while you are alive, providing for the care of you and
your family if you are disabled, controlling the way your property passes, and
saving every possible tax dollar, professional fee, and court cost. Whether your
estate is large or small, you have the right to decide what will happen to it
upon your death. In addition to deciding who should receive your property, your
estate plan must consider the value of your estate, the probate process,
provisions for your care during a period of illness or incapacity, methods to
transfer your property, techniques to reduce or eliminate estate taxes, and the
choice of the persons you want to supervise the transfer of your property or
care for minor children and incapacitated persons.
Working together as
a team produces the best plan
The lawyer preparing your estate plan must have a complete
picture of your personal situation, including your assets and income sources, to
develop the best plan for you. That means the lawyer must not only work closely
with you, but also must coordinate with your accountant, insurance agents, and
investment advisors. A failure to work with these other professionals involved
in your financial affairs may result in unnecessary duplication of efforts and
could bring unforeseen results that defeat the purposes of the plan.
Value of your estate
Before you can decide how best to pass your estate, you
first need to know what actually comprises the property of your estate. Your
estate will include everything you own at the time you die: house, furniture,
savings and checking accounts, securities, insurance policies, retirement
accounts, and annuities. The actual value of your estate can only be computed
after you die. However, to do a good estate plan, you and your lawyer must
estimate the current value of your estate. This estimate is needed to anticipate
and plan for the cost of probate and estate taxes due when you die and to
consider techniques to minimize these costs.
Calculating the value of your estate is not difficult.
First, you prepare a written list of what you own and put a value on each item.
The full value of everything you own by yourself must be included. Part of the
property you own jointly with other persons will also be included. If you own
the property as joint tenancy with right of survivorship or tenancy by the
entirety with your spouse, one-half of the property's value must be included in
your estate if you die first. If you own property in joint tenancy with right of
survivorship with your children and they did not help purchase the property, all
of the value of that property must be included in your estate. When you own
property as a tenant in common, the amount included in your estate will depend
on your fraction or percentage of ownership. For example, if you are a one-third
owner as a tenant in common, your estate will include one-third of the total
value of the property.
The amount of the death proceeds of any insurance policy
you own on your life must be included on your list. Your retirement and annuity
account balances must also be included. If your retirement plan has a survivor
benefit rather than an account balance, an estimate of the survivor benefit's
value must be included. For a discussion of retirement planning, please go to
the Retirement Planning topic on our Web site.
You must also include the value of any trusts that you hold
the power to appoint to yourself and any trusts in which your spouse gave you a
right to income in return for an estate tax or gift tax marital deduction. The
total value of the property you own at your death is called the gross estate.
After you have determined the value of your “gross
estate”, you will subtract from your “gross estate” the deductions
provided to you under the Internal Revenue Code.
Such deductions will include estimates of funeral costs, outstanding
debts, and administrative expenses of settling your estate. If you are married,
you will also be allowed a marital deduction for everything you leave to your
spouse if he or she is a United States citizen. You are also permitted an
unlimited charitable deduction for gifts to charities occurring at your death.
After you subtract these deductions from your “gross estate”, you will be
left with your “taxable estate”.
Estate tax
Under current law, every person
who is a U. S. citizen or a permanent resident may leave a certain amount of
property to others without paying any federal estate taxes. This amount is
called the applicable exclusion amount because it is based on the amount
protected by a credit against estate taxes. The applicable exclusion applies
regardless of the identity, relationship, or citizenship of the persons or
entities receiving your estate. If the value of your taxable estate exceeds the
applicable exclusion amount, estate tax will be due.
The “applicable exclusion”
amount for 2011 is $5,000,000. In 2012, the exclusion amount will be $5,000,000
increased by an amount determined by the inflation index. In 2013 the applicable
exclusion is to return to its 2001 level, which is $1,000,000 adjusted for
inflation.
The estate tax due upon your
estate will be calculated upon your taxable estate after adding to the taxable
estate any taxable gifts you made after 1976 and any gift tax you paid in the
three-year period before your death. Your applicable exclusion amount will be
subtracted from this total to determine the amount of your estate subject to
estate tax. The amount subject to estate tax will be taxed at a rate of 35%.
Since your taxable estate includes everything you owned at death,
including the assets that will be used to pay estate taxes, the estate tax is a
tax-inclusive tax.
Most married couples can avoid
paying estate tax when the first person dies by leaving everything to their
surviving spouse. The unlimited estate tax marital deduction will protect the
property left to the surviving spouse and avoid estate tax. Congress has made
this technique even more effective by authorizing “portability” of any
unused exclusion amount by the predeceased spouse. Portability allows for the
estate of the surviving spouse to carry over any unused exclusion amount from
the first to die’s estate and add that exclusion to the surviving spouse’s
exclusion amount. This, in effect, allows the surviving spouse’s estate to
take a double exclusion equal to $10,000,000 in 2011 and 2012 for deaths
occurring in 2011 or 2012. However, if your combined assets exceed two times the
applicable exclusion amount, leaving everything to your spouse will only defer
the estate tax until the second death. As an example, we will look at the case
of a married couple, Sam and Irene, who acquired property worth $12,000,000
during their lifetimes. If they own all their property jointly or have wills
providing all the property of the first to die goes to the survivor, there will
be no estate tax upon the first death, but an estate tax of approximately
$700,000 will be due at the second death if they both died in 2011 or 2012 and
we use the applicable combined exclusion amount of $10,000,000. For purposes of
illustration, we will assume Sam dies first and Irene dies shortly thereafter
and there is no growth or shrinkage in their property between deaths:
If Sam owned $6,000,000 and
Irene owned $6,000,000:
Sam's Estate Date of
death 5/1/2011
|
Gross Estate |
$6,000,000 |
|
Marital Deduction |
$6,000,000 |
|
Taxable Estate |
0 |
|
Applicable Exclusion
Amount |
$6,000,000 |
|
Amount Taxed |
0 |
|
Tax (rate 35%) |
0 |
|
Amount left to Irene |
$6,000,000 |
Now Assume Irene dies one month later after inheriting
$6,000,000 from Sam:
Irene’s Estate Date of death 6/1/2011
|
Gross Estate |
$12,000,000 |
|
Taxable Estate |
$12,000,000 |
|
Applicable Exclusion
Amount ($5,000,000 carried over from Sam and $5,000,000 for Irene) |
$10,000,000 |
|
Amount Taxed |
$2,000,000 |
|
Tax (rate 35%) |
$700,000 |
|
Amount left to Children |
$11,300,000 |
If Sam and Irene owned
$12,000,000 jointly, the result would be the same:
Sam's Estate Date of
death 5/1/2011
|
Gross Estate (½ of the
jointly owned $12,000,000) |
$6,000,000 |
|
Marital Deduction |
$6,000,000 |
|
Taxable Estate |
0 |
|
Applicable Exclusion
Amount |
$6,000,000 |
|
Amount Taxed |
0 |
|
Tax (rate 35%) |
0 |
|
Amount left to Irene |
$6,000,000 |
Now Assume Irene dies one month later after inheriting
$6,000,000 from Sam pursuant to their joint ownership.
Irene’s Estate Date of death 6/1/2011
|
Gross Estate |
$12,000,000 |
|
Taxable Estate |
$12,000,000 |
|
Applicable Exclusion
Amount ($5,000,000 carried over from Sam and $5,000,000 for Irene) |
$10,000,000 |
|
Amount Taxed |
$2,000,000 |
|
Tax due and payable to
the IRS (rate 35%) |
$700,000 |
|
Amount left to Children |
$11,300,000 |
There are ways to avoid an
estate tax upon the second death by removing property from a person’s taxable
estate. For further discussion of these techniques, please go to the Family
Gifting, Insurance Trusts, and Charitable Gifts topics on our website. It is
important to remember that a married couple owning together more than double the
applicable exclusion amount will have an estate tax due upon the second death
unless they use estate planning to avoid it.
Marital deduction and credit shelter planning for a married couple
Credit shelter planning is a
strategy that can be used when a couple decides not to elect to use portability
in order to carry over the exclusion amount of the first to die. This decision
may be applicable when a couple owns assets which are appreciating rapidly and
they want to keep them out of the surviving spouse’s estate or when a couple
doesn’t want to file an IRS Form 706 estate tax return in order to make the
portability election. If a married couple's combined assets exceed the value of
one person's applicable exclusion amount ($5,000,000 in 2011), and a portability
election is not going to be made, it becomes necessary to engage in estate
planning to avoid estate tax on the second death. The basic estate planning
technique to avoid an estate tax on the second death is a will or trust with a
two-share arrangement. This technique is commonly called “credit shelter”
planning and is sometimes called the A - B trust arrangement. Whatever you call
it, this technique will permit up to double the applicable exclusion amount to
pass to children or other designated beneficiaries without payment of estate tax
on either spouse's death. Under present law, the estate tax is set to revert
back to 2001 figures in 2013, with an applicable exclusion amount of $1,000,000.
(See 2001 Tax Relief Act and 2010 Tax Relief Act)
To make credit shelter planning
work, a mechanism must be in place to permit each spouse to use enough of his or
her applicable exclusion amount upon death to avoid estate taxes on both deaths.
This can be done through formula provisions, disclaimers, or a partial election
of the estate tax marital deduction. The idea is to use some or all of the
first-to-die's applicable exclusion amount to set aside property and protect it
from estate tax on the second death. If a couple's combined assets are valued at
two full applicable exclusion amounts or more ($10,000,000 or more for 2011),
the amount set aside on the first death would have to be the first-to-die's full
applicable exclusion amount ($5,000,000). If a couple's combined assets are
worth less than $10,000,000, the amount set aside should be large enough to
insure the surviving spouse will not have property worth more than $5,000,000
when he or she dies.
This separation of ownership
can be accomplished by having each spouse own assets separately, having assets
separately owned by each person's revocable trust, or by having assets owned in
a joint revocable trust. When trusts are used to divide ownership, the husband
and wife can serve as co-trustees of the trusts and, for all practical purposes,
they both will continue to participate in the management, investment, and other
decision making for all family assets as they did before the division.
In an estate plan using credit
shelter planning, the separate wills or revocable trusts of both the husband and
wife, or the joint revocable trust will contain provisions that divide the
property of the first-to-die or the joint trust property into two parts. The
first part, which may be called the credit shelter share, credit shelter trust,
bypass trust, or family trust, will be the amount protected by the applicable
exclusion amount of the first-to-die. This amount can be distributed to a credit
shelter or family trust for the benefit of the surviving spouse and the
children, to a credit shelter trust solely for the benefit of the children, or
directly to the children. This amount will not be subject to estate tax upon the
second death, no matter how much it grows between deaths, because it will be
forever protected by the applicable exclusion amount of the first-to-die. If
there is any remaining amount of the first-to-die's property or joint trust
property not protected by the first-to-die's applicable exclusion amount, that
amount will be allocated to a marital share. The marital share could be
distributed outright to the surviving spouse, distributed to his or her
revocable trust, or distributed to a marital trust or survivor's trust for the
benefit of the surviving spouse.
If the applicable exclusion
amount of the first spouse is used for a credit shelter trust benefiting the
surviving spouse and the children, the surviving spouse may have significant
rights with respect to the property of the trust. He or she may be the trustee
of the trust, receive all the income from the trust, and withdraw trust property
as needed for his or her health, education, support, and maintenance. The
surviving spouse may also be permitted to withdraw up to $5,000 or 5% of the
trust property annually for any reason and be permitted to appoint the property
of the trust at his or her death among the most deserving of the couple's
children.
If the amount not protected by
the first-to-die's applicable exclusion amount is held in a marital trust or
survivor's trust for the benefit of the surviving spouse, the trust terms may be
very broad or restrictive, depending on the family situation. If broad powers
are desired, the surviving spouse may receive all the income from the trust and
be permitted to withdraw principal for any reason. He or she may also appoint
the trust property at death to anyone. If the family situation involves a second
marriage and children exist from the first marriage, more restrictive terms may
be desired. In that case, the surviving spouse may be limited to only receiving
all the income from the trust and the trust will provide that the assets will
pass to the children of the first marriage when the surviving spouse dies.
Let's apply this credit shelter
trust and marital trust concept to an example in which Sam and Irene have an
estate worth $10,000,000. Instead of the ownership in our previous examples, Sam
and Irene divided their $10,000,000 of assets into equal shares and created
wills or revocable trusts with a credit shelter/marital trust arrangement or
they transferred their jointly owned assets into a joint revocable trust with
such an arrangement. We will assume Sam dies first.
|
Sam’s Gross Estate |
$5,000,000 |
|
Marital Deduction |
0 |
|
Taxable Estate |
$5,000,000 |
|
Applicable Exclusion
Amount (placed in a credit
shelter trust for Irene and their children) |
$5,000,000 |
|
Amount taxed |
0 |
|
Amount of tax |
0 |
|
Irene still has
$5,000,000 of her own assets, plus she has access to the assets in Sam’s
credit shelter trust, with some limitations. |
|
Irene’s Estate
|
Gross Estate |
$5,000,000 |
|
Marital Deduction (None
is available, since Sam died first.) |
0 |
|
Taxable Estate |
$5,000,000 |
|
Irene’s Applicable
Exclusion Amount |
$5,000,000 |
|
Amount Taxed |
0 |
|
Amount of tax |
0 |
|
Amount passed to children
free of estate tax from Irene’s estate and Sam’s credit Shelter trust
combined |
$10,000,000 |
Charitable deduction and credit shelter planning for a single person,
widow, or widower
When a single person, widow, or
widower owns property in excess of the applicable exclusion amount at his or her
death, credit shelter planning can be used in combination with the unlimited
charitable deduction to eliminate or reduce estate taxes. The widow or widower
using this technique gives the applicable exclusion amount outright or in trust
to his or her children or other relatives. The remainder of the estate then
passes outright or in trust to charitable beneficiaries. If the bulk of the
estate is a family farm, ranch, or business, the special value reductions
permitted for such property can be combined with the credit shelter planning to
pass up to $6,000,000 to qualified relatives of the deceased widow or widower.
Because of the lack of a
marital deduction, estate planning for single persons, widows, and widowers may
need to include techniques to remove property from the person's estate before or
after death. There are many techniques that can work very well to reduce or
eliminate estate tax when the estate of a single person exceeds his or her
applicable exclusion amount or the combined estates of a married couple exceed
twice the applicable exclusion amount.
Basics of the Generation Skipping Tax
The generation-skipping
transfer tax is a flat tax imposed at the highest estate tax rate. It is imposed
when property passes to beneficiaries who are two or more generations younger
than the giver's generation. For example, if a giver were to establish a trust
for a child for life with the remainder on the death of the child passing to the
grandchildren, a generation-skipping transfer tax could be imposed on the
property in the trust at the child’s death.
The tax is also imposed where
an interest in property is transferred to a beneficiary in a generation which is
two or more generations below that of the giver, e.g., a transfer by a
grandparent to a grandchild or to a trust for a grandchild. In this situation
the tax becomes very burdensome because it means that if someone makes a gift
during life to a grandchild (or to a trust for a grandchild), or upon death
makes transfers to a grandchild (or to a trust for a grandchild), the transfer
will be subject to two taxes - a gift or estate tax and the generation-skipping
transfer tax.
In tax year 2011, there is a
$5,000,000 exemption from the generation-skipping transfer tax available to each
person without regard to whom or how the generation-skipping transfers are made.
Therefore, a person can establish a trust for children for life and then for
grandchildren for life with a remainder to great grandchildren and fund it with
up to $5,000,000 either during life or upon death, and the trust would be exempt
from the generation-skipping transfer tax for the duration of the trust and
would avoid estate tax at the death of the child and at the death of the
grandchild. The transfer into the trust would be subject to either federal gift
or estate tax depending upon whether it was made during life or at death.
If the assets of a single
person will not exceed $5,000,000 at the death of the person, they will be
covered by the exemption if the person has not used the exemption during life.
If the total assets of a couple will be worth between $5,000,000 and $10,000,000
at the death of the surviving spouse, the assets will be exempt from the
generation-skipping transfer tax, if the couple’s estate planning instruments
are drafted with this tax in mind, and the property is titled correctly.
Because the generation-skipping
exemption is not transferable between spouses, it is important to ensure that
each spouse has adequate assets in his or her sole name (or in his or her
revocable trust) to use the exemption regardless of order of death. Also, it
might be desirable to leave more property to children and not to skip directly
to the grandchildren if part of the exemption has already been used.
A direct gift to a grandchild
that qualifies for the $13,000 annual gift tax exclusion or for the medical or
education tuition gift exclusion, will also avoid generation-skipping transfer
tax.
Gift Tax
After January 1, 2011, the
estate and gift tax are once again unified as one system. The “applicable
exclusion amount” for gift tax is $5,000,000. This means you may give away
$5,000,000 during your lifetime without paying any gift tax. The gift tax
applicable exclusion amount is a lifetime gift tax exclusion amount and is in
addition to the $13,000 you may give as “annual exclusion gifts.” Lifetime
gifts made with the gift tax applicable exclusion amount will reduce the
remaining available estate tax applicable exclusion amount. Language found in
the 2011 version of IRS form 706, used for filing estate tax returns, has also
introduced a concept called “estate tax recapture” which will be an
important consideration for all gift planning.
Basis of Property Acquired from a Decedent
Basis, which is generally
equivalent to the cost of an asset, determines the amount of taxable gain on the
subsequent sale or disposition of the asset. The basis of property acquired from
a decedent is stepped-up or down to the value of the property on the date of
death or at an alternate valuation date six months after death. However, if
property is given to a decedent within one year of death and is inherited by the
giver or the giver's spouse, the basis of the property is not stepped up.
Probate
Estate planning must consider
the impact of two types of probate. Both types of probate are avoidable with
proper estate planning. The first type is living probate. Living probate does
not require a death. Living probate occurs when a minor or an incompetent person
owns or receives property. Living probate may occur when you make an outright
gift of property to a minor child or grandchild. It may also be required when a
person who owns property by himself or jointly becomes incompetent to handle his
own affairs. Under the law, when a minor or incompetent owns property, a
conservator must be appointed by the probate court to protect the interests of
the minor or incompetent. If two persons own real property jointly and one
becomes incompetent, a conservator will also have to be appointed to act for the
incompetent before the property can be sold or transferred.
The conservatorship process is
a court proceeding requiring a lawyer, court costs, conservator fees, and the
continuing supervision of the probate court. The property of the minor or
incompetent cannot be sold or otherwise transferred without court approval. The
court-appointed conservator must account to the court periodically for the
assets of the minor or incompetent. Sometimes, living probate can be more
expensive than death probate because court supervision continues until the minor
reaches legal age or the incompetent dies or regains competency.
The second type of probate is
death probate. Death probate is required if you die with or without a will.
Probate will also be required on the second death of a married couple
when property passes by joint ownership or beneficiary designation on the first
death. Probate is a legal process of ensuring your debts and expenses are paid
and the property you own at death is distributed as provided in your will or as
provided by the law. If you have a will, the personal representative named in
the will is responsible for taking care of probate. If you die without a will,
the court will appoint an administrator to handle the probate process.
In Wyoming, formal probate is
required if a person dies owning more than $150,000 (this limit changes to
$200,000 starting July 1, 2011) in property which is subject to probate.
Informal probate is possible if a deceased’s probate property is
$150,000 ($200,000 starting July 1, 2011) or less. Property which is subject to
probate is property owned in the deceased name only; thus, property owned
jointly, property with beneficiary designations other than the estate of the
deceased are not subject to probate. Both informal and formal probate are public proceedings
requiring a lawyer. Formal probate
is a complicated, time-consuming, and expensive process. Probate files are open
to the public and public notice of the probate must be given in the local
newspaper. This means that anyone can go to the court house and review the
probate documents listing your assets, debts, and who will receive your
property. Based on what they find, they may decide to assert claims against your
estate or contest the proposed distribution of your assets.
Death probate usually requires
six months to a year to complete. It may take as long as two years. During
probate, nothing can be distributed or sold without the court’s approval. This
means your survivors may be dependent upon the court for living expenses, sale
of a residence, and the timing of distribution of their share of your property.
The expense of probate varies
from state to state. If you own real property in more than one state, a probate
process will be required in each state. In Wyoming, your administrator or
personal representative is entitled to collect a statutory fee of approximately
2% of the total value of your probate estate for his or her services and the
lawyer handling the probate is entitled to another 2%. These fees are calculated
on the gross value of your probate estate plus the earnings of the estate during
probate without subtracting debts, mortgages, or other expenses. If your estate
is contested, the court may approve legal and administration costs above the
basic statutory fees.
Probate may be avoided by using a revocable or living trust, joint ownership, beneficiary designations, pay-on-death accounts, and by gifts of property while you are still alive. However, you should not do your estate planning solely with the goal of avoiding probate. Joint ownership and beneficiary designations only postpone probate until the second death, create difficulties if you are ill or disabled, and may cause estate tax complications. A good estate plan should plan for incompetency to avoid living probate and consider the possibility of estate taxes and death probate on both the first and second death.