Will Your Assets Reach The Desired Destination?

Whether Updating or Creating, Steer Your Estate Plan Clear of Trouble

Estate planning has garnered renewed atten­tion ever since Congress passed the Eco­nomic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). Among other changes, the act gradually reduces estate tax rates until 2010, when it eliminates the tax entirely. But that’s for only one year — unless Congress passes more legislation extending this repeal, the estate tax will spring back to life on Jan. 1, 2011, in its pre-EGTRRA form.

So does this mean you should gamble on an extension of the repeal, or coast along with your current plan until the estate tax emerges from its pit stop in 2010? In either case, the answer is an absolute no. In fact, now may be the worst time to abandon your estate plan­ning activities. With tax rates, exemptions and other important rules in flux during the next decade, and the estate tax’s future decid­edly in question, it’s more important than ever to revisit your estate plan regularly and update it as needed. And even if you’re just initiating yours, this is still a good time to get a great start.

Heed Tax Implications

When reviewing your estate plan, first look at current and future estate tax, gift tax and generation-skipping transfer (GST) tax rates as well as the exemptions that apply to each. During your lifetime or at death, you can pass up to the exemption amount to your heirs free of gift and estate taxes. If your tax­able estate is equal to or less than the exemp­tion including taxable gifts made during your lifetime, no federal estate tax will be due when you die. But if your estate exceeds this amount, it will be subject to estate tax.

This year, the estate tax exemption is $1 mil­lion, and it will gradually increase until it reaches $3.5 million in 2009 and disappears in 2010, when the estate and GST taxes are repealed. Also, before being eliminated in 2010, the top estate tax rate (already reduced to 49% in 2003) will gradually decrease to 45% by 2007.

If you have bequests or trust allocations set up in your will, be sure to review them to ensure no unintended results occur. Depend­ing on the wording, your spouse and other heirs could end up with more — or less — than you intended. The GST tax is and will remain equal to the top estate tax rate, while the GST tax exemption will increase begin­ning in 2004 until the GST tax is repealed
in 2010.

The GST tax exemption is indexed for infla­tion in 2003 and will increase to $1.5 million in 2004, and it will continue to grow with the estate tax exemption through 2009. Gifts to “skip” generations also can qualify for the $11,000 annual gift tax exclusion under cer­tain conditions.

The larger exemptions for both the estate and GST taxes mean you should look closely at any formula in a will or trust that puts the entire exemption into a particular trust for children, grandchildren or future generations. For example, in a $5 million estate, the exemption represents 10% of the total estate today, but 70% in 2009.

Plan Gifts Carefully

As alluded to earlier, knowing how and when to make gifts is another critical aspect of estate planning. Those you make during your lifetime that exceed annual exclusions are subject to federal gift tax. But the top gift tax rate, currently 49%, will gradually decrease under current law until it reaches 35% in 2010 (equal to the highest income tax rate).

Meanwhile, the gift tax exemption increased from $675,000 to $1 million in 2002, but it stays at that level through 2010 under current law, even though the estate tax exemption has a number of additional scheduled increases. Fortunately, you can exclude gifts of up to $11,000 per recipient each year. This exclu­sion increases to $22,000 per recipient if your spouse joins in the gift.

Even with the impending estate tax repeal, lifetime gifts still make tax sense — as long as you incur no gift tax. Remember, lifetime gifts remove future appreciation from your estate. So minimize potential estate taxes by gifting property with the greatest future appreciation potential. And to curtail income taxes, gift property that hasn’t appreciated significantly since you’ve owned it, because your basis in the property generally carries over to the recipient, who will owe taxes on any gain when he or she sells it.

Creating a gifting strategy also is important now that the law will eventually eliminate the step-up in basis on assets transferred at death. Currently, if your heirs sell inherited assets, their gain is calculated using the asset’s stepped-up basis (the asset’s fair market value either when you die or on the alternate valuation date six months later) rather than your historical basis. In 2010, this step-up in basis will be limited to $1.3 mil­lion or $4.3 million if at least $3 million passes to a surviving spouse.

So, say you bought 1,000 shares of stock at $10, and the stock is worth $50 per share when you die. Under the old law, your heirs’ income tax basis would have become $50 per share. But, under the new law, once your basis step-up amount is used, your heirs’ basis will be the same as yours was: $10 per share. So even if they sell the shares as soon as they receive them, they’ll have to pay tax on $40,000 of gain, which at the 20% long-term capital gains rate would be $8,000.

While the estate tax is in effect, you may wish to hold off on transferring highly appre­ciated assets until your death, because the basis will be stepped up and capital gain tax can be avoided. For property that has declined in value, your best bet is to sell the property to take advantage of the tax loss. You may then gift the sale proceeds.

Assess Your Personal Circumstances

Although tax laws are indeed important, they’re not the only reason to keep an eye on your estate plan. As your personal circum­stances change, you need to ensure your estate plan accounts for them. For instance, if you inherit money or property, determine how you would like to pass on the additional assets. Also revisit your plan if you have had significant growth from an IRA, profit-sharing plan, pension or other investments. What may have been an appropriate estate plan when your income and net worth were much lower may not fit your situation today.

Conversely, if your financial situation declines, you must also act appropriately. Potential creditor problems or claims against your assets may reduce your net worth, requiring you to update your estate plan before these problems threaten the wealth you intend to pass on to your family or oth­ers. You can take advantage of several ways, for example, to protect your home from creditors. Rules vary by state, and only mar­ried couples can use some strategies. So please con­tact us to help you determine your best solution.

Speaking of family, your children’s lives may also affect your estate plan. Should one develop a physical or mental limitation and require special care, or your or your spouse’s ability to earn income diminishes because of a disability, you may need to adjust your plan to provide for these needs as well as any loss of income.

Then again, perhaps one of your children seems a bit irresponsible when it comes to managing her or his finances. You may sub­sequently decide to put a child’s inheritance into a trust for safekeeping, either perma­nently or until he or she reaches a cer­tain age and can exercise better judgment.

Ultimately, any major life event should trig­ger a reassessment of your estate plan. For instance, are you considering an interstate move? If so, make sure your plan complies with your new home state’s estate and prop­erty laws — especially if you’ve married and are moving into or out of a community prop­erty state. You’ll also want to check that state’s gift and estate tax provisions.

Or if you marry, separate from your spouse, or become a parent or grandparent, you probably want to update your plan because these occasions can alter your financial and tax situations. Additionally, if your spouse or another family member dies, you may need to designate new beneficiaries. And, obviously, should your estate’s executor die, you’ll need to designate a new person to assume this important responsibility.

Avoid the Ditches

Although other tasks may seem to take precedence, never neglect your estate plan. Make sure your wishes are clearly stated, legally sound and financially advantageous. Above all, revisit your plan regularly to ver­ify that you’re steering it in the right direc­tion to account for tax law changes, different gifting strategies and new directions your life may have taken.

Remember, your estate plan isn’t for you — it’s for your family. And failing to plan care­fully could mean not only losing wealth yourself, but also depriving your loved ones of money you want them to have. So please call us; we can help you update your estate plan and avoid the ditches of this complex area of financial planning.

(c)2001-06 Fraser CPA - Last Updated 05/01/2006