v Federal Estate Tax. What is the future of the
Federal Estate Tax Law?
The following is what
the current law provides. The Federal
Estate Tax exemption is now $1,500,000, and the maximum rate is 47%. The exemption will increase to $2,000,000 in
2006, and to $3,500,000 in 2009. In the year 2010, there will be no Estate Tax.
And, in the year 2011, the so-called
"new law" will expire, and there will be reversion to the "old
law"; the Estate Tax exemption will then revert to $1,000,000 and the
maximum rate will revert to 55%.
Over the last several
years there have been attempts by the President and by certain members of
Congress to either repeal the Federal Estate Tax, or to at least increase the exemption
to be in the range of $3,000,000 - $5,000,000.
Now, "all bets
are off" as to whether there will be any change in the Federal Estate Tax
laws.
The momentum has
stopped for significant change in the Estate Tax laws. The government is now facing hundreds of
billions of dollars in clean-up costs for hurricanes in various states,
continuing the Iraq War, and addressing other costly issues such as Social
Security and Medicaid. As the national
deficit grows, it appears less likely that there will be a repeal of the
Federal Estate Tax.
v New Jersey Estate Tax. The New Jersey
Estate Tax has now also become a significant factor. Traditionally proper estate planning dictated
that the first spouse to die would fully "utilize" his or her Federal
Estate Tax exemption by bequeathing the exemption amount of assets into a
"By-pass Trust" for his or her surviving spouse. The objective was to avoid wasting the
exemption of the predeceased spouse. Thus,
the family would obtain full advantage of both
exemptions available to two spouses.
However,
utilizing that type of planning may now result in a New Jersey Estate Tax being
unnecessarily payable at the time of the first death. For example, for an estate of $2,000,000, the
New Jersey Estate Tax which would be due on the death of the first spouse in
2006, by using this type of plan, is $99,600.
For many estates, this tax would be unnecessarily incurred.
Most
Wills which were drafted before 2002 incorporate this traditional type of
planning, and thus need to be reviewed. Your
Wills should be reviewed with this issue in mind.
v Need to Review. In summary, in all likelihood
the Federal and New Jersey Estate Taxes will remain in their current form for
the foreseeable future, and we are strongly recommending that clients review
their estate planning. This is
especially applicable if your Wills were drafted before 2002. Married couples should have an appropriate
"By-pass Trust" in your Will in order for your children to obtain
optimum benefit from both parents' exemptions, but now it is necessary to
consider both the Federal and New Jersey Estate taxes when determining
the appropriate amount to bequeath to the By-Pass Trust.
v Disclaimer Planning. Wills can be
drafted to utilize "disclaimer" planning, which provides the
surviving spouse with great flexibility.
Although not necessarily the best approach in every situation, this plan
does allow the surviving spouse to decide at the appropriate time, that is, at
the time of the death of the first spouse, whether or not a By-pass Trust
should in fact be created in order to best reduce estate taxes for your
children.
v Other Planning Techniques. The following
planning techniques are still very viable options which can provide significant
tax savings:
(a) Gifts. The annual gift tax exclusion increases in
2006 to $12,000 per year per donee. This
means, for example, that if you are married and have two children, and one
grandchild, you could give $72,000 per year.
If you go over the gift exclusion, this will use up part of your Estate
Tax Exemption that is otherwise available at death; but it is usually better to
use the Exemption sooner rather than later.
Also, if you pay tuition and/or medical expenses of a grandchild, those
are completely free of gift taxes.
(b) Family Limited
Liability Company (similar to a Family Limited
Partnership). You could create a Limited Liability Company (LLC)
to which you transfer a portion of your assets and then make tax favorable
gifts of Membership Interests to your family members, the objective being to ultimately
reduce the value of your estate for estate tax purposes. Some recent Court cases say that a
"business purpose" is needed.
(c) Qualified
Personal Residence Trust (QPRT). A QPRT is a trust to which you transfer
your principal or secondary residence for a specified term of years, during
which time you use and live in the residence no differently than you do
currently. At the end of the Trust term,
the residence would pass to the trust beneficiaries or into Trusts for
them. The interest passing to the
beneficiaries is a future interest, the "present value" of which is
less (often substantially so) than the current value of the property, and this
present value will be included in your estate rather than having the future
appreciated value be included in your estate.
(d) Grantor
Retained Annuity Trust (GRAT). A
GRAT is an irrevocable trust to which you transfer assets and receive an annual
annuity for the term of the Trust. The
Trust can be structured so that you "receive back" all of the assets
in the Trust in the form of annual payments, which are determined based on
interest rates provided by the IRS. All
income and appreciation in excess of the allowable interest rate passes to the
beneficiaries of the Trust gift and estate tax-free.
(e) Sales of
assets to next generation. This can
be done through either a regular installment sale, or through a Self-canceling
Installment Note (SCIN). If you sell an
asset to your children and take back a regular Note Receivable, the remaining
balance of the Note will be includable in your estate. If the Note is a SCIN, any balance remaining
at your death would be cancelled and there would be no inclusion in your
estate. Both types provide large estate
tax benefits, and maintain cash flow for you as the seller.
(f) Irrevocable
Life Insurance Trust (ILIT). The proceeds
of any life insurance policy on your life which you own are includable in your
estate for estate tax purposes. An ILIT
is an Irrevocable Trust to which you transfer the life insurance, and once
three years have lapsed the insurance will no longer be includible in your
estate. Any new policy purchased by the
ILIT will immediately be excluded from your estate.
(g) Charitable
Remainder Trust (CRT). A CRT is an
Irrevocable Trust to which you transfer property and retain, for yourself (or
other non-charitable beneficiary) an annual annuity. At the end of the Trust term, the assets
remaining are distributed to one or more charitable organizations which you
have specified. You will receive an
immediate income tax deduction for the value of the interest ultimately passing
to the charitable organizations, and the income and gains of the CRAT are only taxed
when they are received as part of the annual annuity to you (or other
non-charitable beneficiaries)
(h) Charitable
Lead Trust (CLT). By creating a CLT
in your Will, your estate would receive a charitable deduction reducing the
size of your estate for estate tax purposes.
During the term of the Trust, charitable organizations would receive
distributions, and at the end of the term your descendants would receive the
remaining balance. Essentially, you
would be deferring a portion of the amount that your children would receive
from your estate, and shifting the amount that would otherwise be paid in estate
tax to charitable organizations.
(i) Generation-Skipping Transfer (GST) Trust. A GST trust is created by you for the benefit
of your descendants. Assets held in
trust would be available for your children's benefit but would pass
estate-tax-free to their descendants. Each
child could be the Trustee of his or her own trust, could designate the
successor Trustees, could distribute trust assets to other individuals or
entities (with some exceptions) during his or her lifetime, and could determine
how those assets would be distributed upon his or her death. The objective is to protect assets from any
future creditors, and to reduce Estate Taxes otherwise payable by the
grandchildren.
v Elder Law and Medicaid Planning. There have been
numerous changes during the last year or so regarding available planning to
preserve assets for a family when entry into a nursing home becomes
likely. There have been recent Court
decisions regarding the use of commercial annuities and the use of gifting
under a Power of Attorney, which generally makes this planning easier. However, there are some proposed changes in
the Federal Medicaid laws which if passed will severely restrict making gifts
for this purpose.
v Power of Attorney. A Power of Attorney is a
critical document. Every individual with
any assets should have a Power of Attorney in place. If you were to become incapacitated without
having a Power of Attorney, only a Court-appointed Guardian would have the
authority to make decisions and otherwise handle your financial affairs on your
behalf. A recent change in New Jersey
law provides that a "General Power of Attorney" is not as
"general" as it used to be. Previously, if one granted a "General Power
of Attorney", then it allowed the Agent to take virtually every planning
step that you could have done on your own.
Now, if you wish your Agent to be able to make gifts, which is a
critically important facet of estate tax planning, then your Power of Attorney
must specifically contain such gift-giving authority.
v Living Will. A Living Will is also a critical
document. It is advisable that you state
your intentions regarding the maintenance or non-maintenance of artificial life
support in a situation with a terminal illness and no hope of recovery. Also, it is very important that you designate
a Health Care Representative in writing.
If you have not done so, then, generally only a Court-appointed Guardian
would have the authority to make medical decisions on your behalf.
v Titling of Assets. It is important that your
assets be properly titled. Sometimes, having
assets in joint ownership is best - but not always. Depending on the size of a married couple's
estate, it may be best to have some assets separately titled in the husband's
name and some assets separately titled in the wife's name.
v
Designation of Beneficiary.
It is very important that a proper beneficiary designation be
implemented for your IRA or other retirement plans. The income tax and the estate tax combined
could consume over 70% of your IRA.
