Estate Planning

Estate Taxes

There is an old expression that says "you can’t take it with you." One of the reasons that expression is true has to do with your federal and state governments. If you are lucky enough to be on Track 2, one of the biggest transfers at your death may be to the tax collector. We will discuss minimizing these taxes in the section Track 2 Estate Plan.

As important as it is to reduce taxes, these strategies should never come before having your assets go to satisfy your other desires. It’s all right if you want to set up your estate in such a way that results in paying more tax than you might otherwise have to, yet allow you and your spouse complete control of your assets or to benefit someone in particular. No matter what anyone tells you, it’s your money.

Basics Of Estate Taxes

The federal government has set up a tax system to collect a certain amount when you die if you leave an estate over a certain amount. This tax was originally intended to prevent extremely wealthy families from holding onto their fortunes from generation to generation instead of turning assets back to the government to help run the country. With rising real estate and pension values and more people owning life insurance policies, a lot of Americans find themselves among this “elite” group. The tax rates on estates can be as high as 45% in 2007, potentially making the federal government one of your major beneficiaries when you die with a sizable estate.

Generally, if you have more than the applicable exclusion amount ($2,000,000 in 2007) in your estate, you may have to pay an estate tax. For tax purposes, your taxable estate is defined as your estate (including assets that are not part of probate such as pensions, joint property, life insurance, and IRAs) less expenses, certain deductions, and exemptions.

CAUTION: If you are the trustee in a trust where you can appoint assets back to yourself (or pay your creditors) the entire value of this trust may be included in your estate.

CAUTION: Estate taxes have nothing to do with the income taxes that you have to pay every April 15.

In determining your taxable estate, you are generally allowed to deduct any debts the estate has (excluding estate tax), any expenses paid to the executor, attorneys or accountants in settling the estate, and qualified charitable donations. If the state charges a state death tax, you can get a credit for some of the tax paid to the state.

Any property transferred to a spouse is deducted from your taxable estate. This is called the Unlimited Marital Deduction. In many cases, this is how you can postpone estate tax until the surviving spouse dies. There are a few limitations on this deduction, so if you are thinking of leaving assets to your spouse in a trust or otherwise restricting his or her use of the assets, ask your attorney or other estate planning professional if you will be jeopardizing this important deduction.

CAUTION: The unlimited marital deduction does not apply to transfers to a spouse who is not a U.S. citizen. Special rules have to be followed. If this applies to your spouse, find an attorney that is knowledgeable in this area of estate planning.

Estate Applicable Credit Amount

The estate applicable credit amount essentially allows you to transfer a certain amount of assets at death free of estate tax. The amount of assets you can transfer is known as the Applicable Exclusion Amount $2,000,000 in 2007. The estate applicable credit amount will increase based on a phased-in schedule so that by the year 2009 every person may transfer $3.5 million of assets at their death free from estate tax. For a schedule of the applicable estate exclusion amounts, see the section The Applicable Exclusion Amounts in the Track Planning section.

Unfortunately, the applicable credit is one thing you cannot pass on to your family. If you do not use your applicable credit on your estate taxes, it is not passed on to your spouse. The credit simply vanishes. If the first spouse to die has not used his or her applicable credit, the surviving spouse’s estate may ultimately have to pay more estate tax.

Transfer Tax Rate Schedule-2007

Here is a table you can use to estimate the tax on your estate or a large gift. The figures are as stated under current law. Contact your tax advisor to verify any rate changes.

Taxable Amount

= Tax*

$750,001 to $1,000,000

$1,000,001 to $1,250,000

$ 64,200

Over $1,500,000

$ 119,200

*Equals tax before applicable credit

Once you have calculated your estate tax using the chart above, you can reduce that figure by the estate applicable credit amount below. The amount of the credit depends upon the year of death. (The gift tax applicable credit amount is separate and is fixed at $345,800.)

Estate Applicable Credit Amount

$1,455,800

Here is an example to show you how the calculation works:

Tom dies in the year 2007 with a taxable estate of $2,050,000. His federal estate tax liability is calculated as follows:

Taxable estate

x Tax Rate

$803,300

Minus Applicable Credit - year 2005

$780,800

$22,500

CAUTION: Consult with your tax advisor for an exact calculation of your estate tax liability.

Comprehensive Estate Tax Example

The following example illustrates the estate tax calculation.

Assume your will splits your estate between your spouse and son. You die in 2007 with the following assets:

House (son is designated beneficiary)

Pension (spouse as beneficiary)

$130,000

Jewelry and other Personal Property

$1,270,000

Less: Executor Fees

In this example, the $850,000 going to the spouse qualifies for the marital deduction and is not taxed. The $350,000 going to the son is less than the 2007 applicable estate exclusion amount of $2,000,000, so the applicable credit reduces the tax to zero.