Some Estate Tax Basics

As we tread toward the summer of 2009, many former and new clients are cropping up to either revisit their existing estate plans or sit down to prepare plans for the first time. Ford & Mathiason’s estate planning clients generally fall into one of two categories, and the total value of the estate is usually the variable that determines what type of plan is appropriate. For estates (combined for married couples) valued at less than $1 million, our attorneys will usually only be engaged to prepare or revise simple plans using routine Wills, Medical Powers of Attorney, Statutory Durable Powers of Attorney and Directives to Physicians. For those clients whose total estates exceed this mark, we will often discuss some of the more complex planning techniques to account for the possibility that the Federal Estate Tax may rear its head in the future.

The Federal Estate Tax, often appropriately referred to as the “Death Tax,” is, in general terms, a tax imposed on the transfer of wealth by virtue of an individual’s death. Yes, there are two unavoidable things in this world, and Uncle Sam makes sure you don’t forget that he is one of them. Sam also takes a pretty big bite for the unwary taxpayer, and though there are certain exemptions and deductions, the effective tax can act to cut a Decedent’s Estate in half before the remainder is ever distributed to the beneficiaries under a Will, or to the Decedent’s heirs in the absence of a Will. With that consequence in mind, many clients want to make sure that they understand at least the basics of a tax that could have a very large impact on their families and loved ones.

In order to determine if the tax might apply, planners first look to the “gross estate” of the Decedent. I often explain to my clients that the Federal government casts its net as wide as possible in order to determine a base to tax from. Start with everything that the Decedent owns at his or her death, including all of the separate property and the one-half of any community property. This is where most clients stop the analysis, but your government goes further than most think. For example, certain property transferred by the Decedent within 3 years of death may be included. Property the Decedent transferred but retained a life estate in may be included. Even assets that most people understand to be “non-probate,” such as life insurance, retirement accounts and annuities, may be included in the “gross estate” that forms the starting point of any estate tax analysis.

With the “gross estate” tallied, the focus shifts to available deductions, and this is where some of the most basic tax-planning strategies come into play. An individual’s “gross estate” can be whittled down by several things, including funeral expenses, expenses of estate administration, property passing to certain charities and property passing to a surviving spouse, just to name a few. When the tentative tax is calculated, certain credits are applied. The credit with the greatest impact is the “unified credit.” This is the dollar amount clients often know the most about, since it has received a fair amount of press coverage over the last several years. In a nutshell, the “unified credit” results in an exemption or “applicable exclusion,” which serves as the threshold to determine whether or not any tax is owed. For the last three years, Estates of less than $2 million owed no tax. For 2009, this number increased to $3.5 million, and has the ultimate effect of removing many Estates from taxation – at least for the next few months.

If uncertainty worries you, plunk your head in the sand now. If, on the other hand, debate and uncertainty intrigue or energize you, stay tuned. Both are brewing on Capitol Hill with regard to the estate tax. A little more than a month ago, the United States Senate voted 51-48 to permanently cut the tax rate to 35% and exempt all estates of less than $10 million per couple ($5 million for a single taxpayer). The concept means that fewer estates would pay the tax, and the hope is that families would reinvest the untaxed inheritance, thereby spurring economic growth. Earning traction for this idea should prove challenging and at least politically entertaining, since our country finds herself in the midst of economic turmoil, budget nightmares and tepid bipartisanship at every turn.

The last chapters on the Estate tax simply have yet to be written, which makes thoughtful and educated estate planning an absolute necessity. By its nature, estate planning involves planning ahead for unknown circumstances. Pending legislation adds another variable, and if your current estate plan is less than prepared, you might do well to learn a bit more. As lawmakers begin to polish their talking points, we should all perk up and pay attention to the issue.