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Olsen Skoubye & Nielson, LLC
999 Murray Holladay Road, Suite 200
Salt Lake City, Utah 84117
(801) 365-1030 (phone)
(801) 365-1031 (Fax)
info@osnlaw.com
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Estate Taxes
Estate and Gift Taxes:
The federal government and many states have established taxes which apply to the gifting of property during lifetime and at death. Utah currently has no estate tax, therefore the discussion here will focus on the federal estate and gift tax. This tax can be avoided by most people with early planning.
The simplest way to look at the estate tax is through an analogy. It is as if each of us is pushing a grocery cart through a grocery store. As we go we put things in our cart; that is, we accumulate assets. During our lifetime we are allowed to transfer up to $13,000 per year per person (called the annual exclusion - currently indexed for inflation) to another's grocery cart. When we go to check out of this life (we die), all of the assets in our cart are subject to estate tax when they pass over the checkout stand. However, each person has been given a coupon currently worth $3,500,000, so the first $3,500,000 passes through the checkout stand without any tax (so long as it was not used during life through gifting). Every dollar after that is subject to a tax of 45%.
These rates are the same for gift taxes, thus a "unified tax" system. The "coupon" is referred to as the applicable exclusion amount. I will just refer to this as the exclusion amount or the coupon amount. This coupon amount may be used during life or at death. If we exceed the annual exclusion amount in any in year we are subject to a gift tax or using up some of our coupon amount. If the coupon is not used at death it is lost entirely.
Currently the coupon amount is increasing. The following table shows how these increases will take place.
Year Exclusion Amount Top Estate Tax Rate
2009 $3.5 million 45%
2010 Estate Tax Repealed Estate Tax Repealed (35% Gift Tax Rate)
2011 $1 million 55%
You may ask, what is included in my estate for tax purposes? The answer is, your entire net worth, including the face value of any life insurance in which you have any incidents of ownership at your death. Put another way, add up the value of all of your assets, subtract your liabilities, and include your life insurance at face value.
As you can see, the estate tax is a significant expense for those effected by it. Congress may change this system in the coming year to avoid the repeal set to occur in 2010 and the reintroduction of the tax in 2011.
Estates Under $3,500,000:
For a single individual or a couple whose total net worth is under $3,500,000, and unlikely to exceed this amount in the next few years, no estate tax planning is likely warranted.
As described above, each individual is given a coupon worth $3,500,000. Therefore, if your net worth as described above, is below this amount, no estate tax will be due on your death and no estate tax return will be required.
For a couple, your combined net worth must be under this limit or the assets will be subject to an estate tax at the death of the second of you.
Although estate tax planning may not be necessary for you, estate planning is still critical to handle the following issues:
- Probate Avoidance
- Asset Protection
- Providing management of assets for young beneficiaries
- Guardianship for minors or incapacitated persons
- Long term care issues
- Terminal Illness and Health Care
Estates Over $3,500,000:
It is my philosophy to work from simple to complex for my clients. I believe we should do only the planning that is necessary to deal with the issues and no more and that the planning that we use should be the simplest possible to address the issue. Options that provide control and flexibility should be at the top of the list.
For clients with net worth in excess of $3,500,000, the most simple, flexible option for dealing with the tax problem is what is commonly referred to as an A-B Trust Plan. The best way to understand this plan is to return to our analogy.
Each individual has a coupon worth $3,500,000 that they may use during their lifetime or at death to avoid estate tax. The first $3,500,000 that passes over the checkout counter is free of any estate tax regardless of who receives the asset. After that, each dollar that passes over the checkout counter will be subject to a tax beginning of 45%.
Any amount placed in the spouse's basket, rather than passed over the checkout counter, is not subject to estate tax at the death of the first because it doesn't leave the grocery store. But the coupon is use-it-or-loose-it. So at the death of the first, if everything is passed to the surviving spouse's basket and nothing passes over the checkout counter, the coupon amount is lost.
Since each spouse has a coupon amount worth $3,500,000, if we could just preserve the coupon of both spouses we should be able to pass up to $7,000,000 without any estate tax consequences. The way we preserve the coupon is like this:
At the death of the first spouse to die, we tell the checker at the check out counter: "Pass up to $3,500,000 in assets over the counter, but anything beyond this amount, place in my spouses basket. Take the assets that are checked out and bag them and place them in that red cart over there. Then pass the red cart back over here and let my spouse push that through the grocery store for the remainder of his or her life. Here is my coupon for $3,500,000, therefore, there is no tax on the assets passed over the checkout counter. And any amount beyond the $3,500,000 goes into my spouse's basket and will be taxed at his or her death, so there is no tax on these amounts. Therefore, no tax is owing now."
The survivor now pushes their own cart and the red cart through the grocery store. At the death of the survivor, the red cart passes right around the checkout counter because it has already been paid for. It is the same as though you had purchased something and were carrying the bag with the already purchased item through the grocery store. The store doesn't charge you for the item twice. The assets in the surviving spouse's basket are then passed over the checkout counter, but the survivor still has his or her coupon which will cover up to $3,500,000. So, no estate tax on the first $3,500,000. Any amount beyond this limit will still be subject to the tax.
By preserving the coupon of both spouses we can effectively pass up to $7,000,000 in assets to the next generation estate tax free. This is a savings of up to $1,750,000 in taxes that without the planning would be paid to Uncle Sam!
The legal structure for this A-B Trust Plan is to establish two trusts, one for the husband and one for the wife. We then divide their assets between the two trusts in approximately equal amounts. We do this to insure that we do not waste the coupon should the spouse with the smaller estate die first since the government will not allow us to pass assets from the living spouse to the deceased spouse in order to use up the deceased spouse's coupon.
The trusts each provide that upon death, it divides into two separate trusts, a Family Trust (sometimes referred to as the bypass trust, credit shelter trust, or B Trust -- in my analogy, this is the red cart) and a Marital Trust (in my analogy, this is considered the same as the spouse's cart). The trust uses a formula to divide the assets between these two trusts which can be tailored to the needs of the particular client. Most commonly, the formula provides for the Family Trust to receive up to the coupon amount in assets. Any amount of assets beyond this amount goes to the Marital Trust. No tax is paid at the death of the first spouse, and at the death of the surviving spouse, the Family Trust is not considered an asset of the surviving spouse and is therefore not subject to estate tax at his or her death.
For clients with net worth over $3,500,000 and less than $7,000,000, an A-B Trust Plan is sufficient to avoid all estate tax and this is where the estate tax planning will usually stop. This plan is very flexible since it is revocable during the lifetime of both spouses and can be modified at any time to deal with changes in the law or family circumstances. Only after the death of the first spouse does the first to die's trust become irrevocable.
For those with net worth in excess of $7,000,000, the AB Trust Plan is only our starting point. Once this piece is put into place, we then look at other additional planning options to avoid the estate tax on the amounts in excess of $7,000,000.
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