By Norman A. Pappas
The estate tax lifetime exemption increased to $3.5 million per person as of Jan. 1, 2009. What does this mean for your estate plan?
Unfortunately, what happens beyond 2009 remains uncertain. Under the current legislation, there will be no estate taxes at all in 2010, and in 2011 the exemption reverts back to $1 million. This scenario is not likely to occur. The most likely scenario is that there will be permanent estate tax reform in 2009, keeping the exemption at $3.5 million. This change will affect all estates, but reviewing your estate plan is especially important if your estate is on the modest side - $2 million to $10 million - and your documents were written when the exemption was lower.
The first thing to check is whether your estate values are balanced between husband and wife so that each takes advantage of their individual lifetime exemptions. If you have a $7 million combined estate, you will not avoid estate taxes unless each of you has $3.5 million in properly funded exemption trusts. If one spouse just has $1 million and dies, $2.5 million of available exemption would be lost and become an asset in the survivor’s estate, subject to tax.
Check how the exemption trusts are written, particularly if you have a combined estate of less than $7 million. If your total estate is $4 million, and the trust is written so that the maximum exemption amount goes to the children, the surviving spouse could wind up with inadequate assets, with the majority passing on to the children.
The generation-skipping transfer allowance is also up to $3.5 million. Many documents were written when the exemption was $1 million and directed that the maximum amount available go to the generation-skipping trust. Again, this could have unintended consequences for smaller estates. The lifetime gift exemption remains at $1 million. Despite the higher exemption available upon death, it may still make sense to give away your lifetime maximum and pay the tax. This removes appreciation from your estate and may provide discounts, depending on how the gift is structured.
Second marriages need document reviews. Often Q-TIP trusts were used to allow a second spouse use of income during his or her lifetime and pegged the amount that would go directly to the children at $1 million. That amount may warrant adjustment now.
Other Things To Consider
Check IRA designations to see if you might benefit from a credit shelter trust. Consider if a spousal disclaimer might be an appropriate strategy for your estate.
Review your state’s estate tax laws, as many have decoupled from the federal estate tax system and now charge their own inheritance tax. (Fortunately, Michigan is not among them.)
Review your life insurance funding; life insurance is an excellent asset class for paying estate taxes, as well as providing security for kids and grandkids.
Finally, the annual gift exclusion increased to $13,000 in 2009. It is still wise to use this, even though your total estate may be less than $7 million. Remember that an estate worth $7 million today can reasonably be expected to grow over a lifetime. Annual exclusion gifts are an ideal funding source for a life insurance trust.
Finalizing estate tax reform will create certainty and many opportunities, but it also creates a lengthy “to do” list. If you start by reviewing your current estate plan, you will be ready to make the changes you need to at the right time.
Norman Pappas is president and founder of Pappas Financial and the author of several articles on business and estate planning topics. His book, Passing the Bucks, is a guide to business succession and wealth transfer planning. He can be reached at [email protected].