Under current law, the federal estate tax is scheduled to rise from the ashes on January 1, 2011, and begin attacking the affluent middle class along with the wealthy. People who didn't have to pay much attention to this tax in recent years will need to make it part of their financial planning. And it's not too soon to start taking the necessary steps.
Come next year, the amount of each estate that is exempt from tax will be just $1 million, and the tax on the rest will be 55% (60% in some cases). That means a lot more families will be affected by the tax than in 2009, when the tax-free amount was $3.5 million and the rate was 45%. Congress could change this plan, put in place a decade ago as part of the Bush tax cuts, but recent events make that increasingly unlikely.
As in the past, assets left to a spouse or to charity won't be subject to the tax. But a widow or widower with a home and a retirement account could easily be leaving more than $1 million to children, and that inheritance would be taxed. Unmarried and same-sex married couples will be particularly hard hit since they do not enjoy the estate tax breaks available to spouses.
Many strategies to reduce the government's take involve giving away assets while you are alive--something not everyone can afford to do. For those prepared to shed some wealth that way, there are gift tax rules to navigate. The gift tax, which is currently 35% and will rise to 55% next year, applies to certain transfers that exceed the $1 million limit on lifetime gifts. Note that if you use any part of the $1 million amount, it gets subtracted from the estate tax exemption that's available when you die.
So what can you do now? The following simple strategies can help you avoid blunders that would trigger tax unnecessarily, and minimize Uncle Sam's share of what you leave behind.
Maximize annual gifts.
Anyone can give cash or assets worth up to $13,000 a year to anyone else without it counting against that $1 million lifetime gift exemption. Married couples can combine their yearly gifts to give away up to $26,000 to as many people as they like. For example, a couple with an adult child who is married and has two children could make a joint cash gift of $26,000 to the adult child, the child's spouse and each grandchild--four people--providing the family with $104,000 a year. (See "Five Tax-Free Gifts To Family.")
Review life insurance policy ownership.
If you or your spouse own policies on your own lives, the proceeds could be subject to estate tax. One way to avoid that result is to designate the family member who will receive the proceeds of the policy--say, an adult child--as the owner of the policy. And using your yearly $13,000 gift exclusion, you can give them the money to pay the premiums.
If you don't want these beneficiaries to receive the insurance proceeds outright, you can set up an irrevocable life insurance trust. Typically the ILIT buys the policy and, when you die, holds the proceeds for whomever you've named as beneficiary or beneficiaries. As with any trust, you can set conditions on the use of the money--perhaps, for example, it's to go for the payment of your children's or grandchildren's college expenses.
With this set-up too, you can make annual gifts to finance the premiums, but there's a caveat: One condition for the annual exclusion is that the gift must be a present interest, meaning something the recipient can use right away, rather than a future one. The most common way to satisfy this requirement is to give beneficiaries Crummey powers--the right for a limited time, usually 30 or 60 days, to withdraw from the trust the yearly gift attributable to that beneficiary.
Each year, the trustees must send a notice, called a Crummey notice, to the beneficiaries (or the parents, if the beneficiaries are minors) letting them know about their right to withdraw their portion of the annual gift to the trust. (Crummey was the name of the family which first got the court's blessing to use annual gifts this way.)
If you already own a policy, you can transfer it to the trust. Warning: If you die within three years of making the transfer, the proceeds would generally be included in your estate. A work-around with term policies is to let the original policy lapse and have the ILIT buy a new one.
Put some assets in your own name.
The estate tax exemption applies to each of us personally--it's not something that we share with a spouse or partner. So to use it, you must have assets of your own. Jointly held property (for example, real estate or bank accounts titled joint tenants with right of survivorship) doesn't count because when one owner dies, full ownership automatically passes to the other. (For more on asset titling traps, click here.)
Unromantic as it may sound, look over your
