Year-End Estate Tax Planning

Author: Ronald E. Lyons Date: 12/07/2010

Categories: Estate Planning and Administration, Tax Services

A full year ago, estate planning attorneys were assuring clients that Congress would never allow the federal estate tax to lapse. There was near universal belief that Congress would either implement a permanent “fix” by establishing an exemption in the range of $3.5 – $5 million or, at a minimum, extend the 2009 exemption of $3.5 million for another year or more. The unthinkable happened and, for 2010, the federal estate tax exemption lapsed.

For those dying during 2010, there is no federal estate tax regardless of the size of the gross estate. Accordingly when extraordinarily wealthy individuals died earlier this year, such as George Steinbrenner, the billionaire owner of the New York Yankees, no federal estate tax was assessed. While there are limits on the step up in basis on the property transferred through the estate, that pales in comparison to the tax revenues lost. The step up in basis is limited to the first $1.3 million dollars and $3.0 million for assets transferred to a surviving spouse.

The issues to be considered by both estate planning attorneys and their clients will likely continue into 2011 if Congress fails to act. As of January 1, 2011, the federal estate tax will be automatically resurrected and applied to the estates of all decedents with a gross estate of one million dollars and above. Moreover, the federal estate tax rate will kick in at an eye popping 55%.

The prospect of a $1 million dollar exemption will require that many more families undertake estate planning for the federal and state estate tax. Even with depressed home values, it doesn’t take very much to tip the scales especially when you add in the value of life insurance owned by a decedent along with retirement accounts. When you add in the separate (and additional) estate tax for estates of decedent’s domiciled in Maryland and the District of Columbia that have gross estates in excess of one million dollars, the total estate tax liability becomes rather daunting. There are, however, some strategies to consider in reducing the fallout of the estate tax dilemma including the following:

  1. Split title of some jointly held assets into individual names. Most estate plans are based, in part, upon being able to take full advantage of the available exemption upon the death of the first spouse. Accordingly, if a couple has a stable marriage, they should consider holding some assets in their own name so that, upon their death, those assets can be used to fund a bypass trust.
  2. Take advantage of the annual donee gift exclusion. Currently, every person can give up to $13,000 per person per calendar year to as many others as they want. When done in conjunction with a spouse, they can gift split and give up to $26,000 per person per year. Such gifts are free of gift tax and do not reduce your $1 million dollar lifetime gift tax exemption. Although cash is the most common form of gift, interests in other assets such as real estate as well as stock and membership interests in LLC’s can also be used. Note that there is no carryover of unused exclusions from one year to the next.
  3. Review ownership of life insurance policies. While life insurance proceeds are not subject to income tax, the death benefit proceeds paid on a policy are included in the gross estate of the decedent and, thereby, subject to estate tax, if the decedent was the owner of the policy. This occurs because the decedent retained “incidents of ownership.” There are many ways to prevent this. The easiest way to avoid this is by having other family members serve as the legal owner of the policy. This is viable where the insured is comfortable and trusting that the other family members will retain the policy in good standing and use the proceeds as the insured desired. Alternatively, the policy can be transferred to, or purchased by, an irrevocable life insurance trust. The trust then becomes the owner of the policy and the insured makes periodic gifts to the trust to cover the premiums. In order for the gift to qualify under the annual gift exclusion, the recipient must have a “present interest” in the gift. That occurs by having the trustee issue a written notice to the beneficiaries of the trust (known as a Crummey letter) giving the beneficiaries a fixed amount of time to withdraw the gift from the trust before the trustee elects to use the gift to pay the insurance premium.
  4. Pay tuition and medical expenses. Without reducing the amount of the annual donee gift exclusion, discussed above, taxpayers can pay tuition, dental, and medical expenses on behalf of others. The only condition is that such expenses be paid directly to the provider of the services.
  5. Fund college savings plans. Section 529 plans are outstanding vehicles for funding the cost of educating your children and grandchildren. Parents, grandparents as well as other family members and friends can all contribute. The earnings in a 529 plan are exempt from federal and state income tax provided that the account is used to pay tuition and certain other related education expenses. Moreover, the law allows for lump-sum deposits of $65,000 ($130,000 for married couples) provided that you file a gift tax return that treats the gift as if it had been spread over five years.

It will be necessary to see what Congress does in the coming months. The items set forth above are just some of the year end steps that can be taken to save taxes. By contacting us, we can help tailor a particular plan that will work best for you.