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Federal Estate Tax Planning

 


Note: In all cases, when implementing an estate plan, legal advice is a must!

Federal Estate Tax Planning is a must or, the government may take a large part of your estate. Figuring estate tax is complex, and the phase out of the tax through decreases in the top estate-tax rate and increases in the estate-tax credit makes the computation even more complicated. However, to effectively plan your estate, you need at least a basic understanding of how the tax works.

THE FEDERAL ESTATE-AND GIFT-TAX EXCLUSIONS

Every individual is allowed a credit that permits a certain amount in assets to pass free of estate and gift tax. So, if your total taxable estate and lifetime gifts are less than or equal to the applicable credit exclusion amount (see below), no federal estate tax will be due.

(The gift-tax exclusion amount is $1 million.) To illustrate: In 2007, the credit will offset $780,800 in estate taxes. If you die in 2007 with a
taxable estate of $2.1 million, having made no taxable gifts during life, the tentative estate tax will be $825,800. However, assuming your estate has no adjustments other than the estate-tax credit, the actual tax will be $45,000 ($825,800 – $780,800).


ESTATE VALUE

For a general idea of how much tax, if any, will be due on your estate, estimate the current value of your estate worksheet. Then subtract allowable deductions. These deductions may include, but aren’t limited to:

 

Estate administration fees;

 

 

Funeral expenses;

 

 

Valid debts, such as your mortgage and unpaid property or income taxes;

 

 

Transfers for public, charitable, and religious uses; and

 

 

Bequests to your surviving spouse (see Unlimited Marital Deduction, discussed in next section).

 

Next, add in the value of any taxable lifetime gifts you have made. Check this amount against our tax table to get an idea of the amount of tax your estate would owe if you should die in 2007–2008.


TAX RATES AND EXCLUSION AMOUNT
 



The generation-skipping transfer tax is assessed at a flat rate equal to the top gift- and estate-tax rate.

**Gift tax only. Estate and generation-skipping transfer taxes (discussed later) are repealed in 2010.



THE GENERATION-SKIPPING TRANSFER TAX

Another possible concern for the near future is the generation-skipping transfer (GST) tax. This tax
could come into play if you want to leave your assets in a way that will benefit your grandchildren or
other persons more than a generation younger than you. The GST tax rate is steep — equal to the highest federal estate-tax rate (see the
Tax Rates and Exclusion Amount table). GST tax, which is
being phased out on the same schedule as the estate tax, must be paid
in addition to estate and
gift tax.


The purpose of the GST tax is to prevent families from sidestepping a generation’s worth of estate
taxes by transferring assets to grandchildren, rather than to children. GST tax applies both to indirect transfers made in trust (for example, a trust that benefits your child first and, then, your grandchild after your child’s death) and to “direct skips,” transfers made directly from you or from a trust you create to a grandchild or another person two or more generations below your generation.


A cumulative $1.5 million GST tax exemption gives you leeway to transfer up to that amount to your grandchildren or others free of the GST tax. If you and your spouse agree to split gifts, together you can give your grandchildren up to $3 million without incurring the GST tax. This exemption tracks the
estate-tax exclusion amount (see the
Tax Rates and Exclusion Amount Table).


The GST tax does not apply to direct transfers and certain transfers from trusts you make to a
grandchild whose parent — your child — is deceased. GST-tax-free transfers to “collateral” heirs
(such as a grandniece or grandnephew) may also be possible under limited circumstances.


THE GENERATION-SKIPPING TRANSFER TAX


Another possible concern for the near future is the generation-skipping transfer (GST) tax. This tax
could come into play if you want to leave your assets in a way that will benefit your grandchildren or
other persons more than a generation younger than you. The GST tax rate is steep — equal to the highest federal estate-tax rate (see the
Tax Rates and Exclusion Amount table). GST tax, which is
being phased out on the same schedule as the estate tax, must be paid
in addition to estate and
gift tax.


The purpose of the GST tax is to prevent families from sidestepping a generation’s worth of estate
taxes by transferring assets to grandchildren, rather than to children. GST tax applies both to indirect transfers made in trust (for example, a trust that benefits your child first and, then, your grandchild after your child’s death) and to “direct skips,” transfers made directly from you or from a trust you create to a grandchild or another person two or more generations below your generation.


A cumulative $1.5 million GST tax exemption gives you leeway to transfer up to that amount to your grandchildren or others free of the GST tax. If you and your spouse agree to split gifts, together you
can give your grandchildren up to $3 million without incurring the GST tax. This exemption tracks the estate-tax exclusion amount (see the
Tax Rates and Exclusion Amount Table).


The GST tax does not apply to direct transfers and certain transfers from trusts you make to a
grandchild whose parent — your child — is deceased. GST-tax-free transfers to “collateral” heirs
(such as a grandniece or grandnephew) may also be possible under limited circumstances.

CAPITAL GAINS TAX


Currently, capital gains taxes are more of a financial planning consideration than an estate-planning
one. But this is likely to change in the future. With the estate-tax repeal comes a change in the way
capital gain on inherited property is taxed.


You pay capital gains tax on gains realized when you sell property that has increased in value while you’ve owned it. Your gain (or loss) for capital gains tax purposes is usually determined by using your “basis” in the property. Basis generally refers to the amount you paid to acquire the property, plus or minus various adjustments that may be required after acquisition (for items such as depreciation, reinvested dividends, and the cost of capital improvements). Your gain is the value of the property in excess of your basis.

When you give someone assets during your lifetime, your basis (or the fair market value of the assets,
if less) on the gift date is carried over and becomes the recipient’s basis. If the recipient later sells the
gift assets, he or she is liable for capital gains tax on the assets’ appreciation both
before and after you made the gift.


Inherited property is treated differently. It usually receives a “step-up” in basis to its fair market value at the time of the owner’s death. So, if you leave property to your son and he later sells it, he’ll be responsible for capital gains tax only on the appreciation generated after your death. However, as of 2010, new rules apply for determining inherited property’s basis. The new rules limit basis step-ups
and, in many cases, will result in significantly higher capital gains taxes on the sale of inherited property.


In 2010, each estate generally will be able to increase the basis of property transferred only up to a
total of $1.3 million. The basis of property transferred to a surviving spouse may be increased by an additional $3 million for a total of $4.3 million. These amounts will be adjusted annually for inflation.


Some property — tax-deferred money in retirement plans and Individual Retirement Accounts, for example — won’t be eligible for even the limited step-up. Any property that isn’t allocated a basis
step-up will pass to your heirs and beneficiaries with a “carryover” basis equal to the
lesser
of (1) your adjusted basis in the property or (2) the property’s fair market value on the date of death.



COMPARING CAPITAL GAINS TREATMENT

Earl owns closely held stock that he bought at $10 a share. When he dies in 2010, his daughter Gretchen inherits the stock, now valued at $500 a share. Shortly after his death, Gretchen sells the stock for $500 a share. Under the new carryover basis rules, Gretchen will have a capital gains tax bill of $98 on each share sold (20% capital gains tax rate × $490 appreciation). If Earl had died before 2010, Gretchen would have owed no capital gains tax because her basis in the stock would have been stepped-up to its value at Earl's death — $500 a share — and she wouldn't have realized any capital gain on the sale.


NEXT  Estate Planning Strategies

Author’s note:  The intent of this article by termlifeamerica.com is to inform and motivate the general public into action.  One should consider only a qualified practicing legal individual or entity, in the state in which you reside, to establish properly drawn documents of this type.

SEE
 Estate Planning Brochure


Related Topics:

get a quote  Estate Planning Needs
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 BUILDING AND CONSERVING YOUR ESTATE

get a quote  Using "Will Substitutes" To Avoid Probate
get a quote  Federal Estate Tax
get a quote  Estate Planning Strategies
get a quote  Wills, Trusts, Probate, and You HERE!
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 Living Wills HERE!

get a quote  Living Trusts HERE!
get a quote  Estate Planning Trusts HERE!
get a quote  1035 Life Insurance Exchange
get a quote  Revocable Trusts HERE!

 

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