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What You Need to Know About the Estate Tax

Favorable estate tax law changes made by Congress in late 2010 may impact you and your family. Learn what the new rules are and whether you need to take action now.

1. What are the federal estate tax rules through 2012?

For those who die before 2013, there is a $5 million exemption amount. This means someone dying with an estate consisting of assets valued up to $5 million will have no federal estate tax.

Even larger estates can pass tax free. There continues to be unlimited marital and charitable contribution deductions. For instance, if you have an estate of $6 million and you leave $1 million to charity, there is no estate tax; the $5 million exemption amount plus the $1 million donation shield all your assets from taxation. The Tax Policy Center estimates that there will be only about 3,600 taxable estates in 2011.

There is a new concept, called “portability,” that married couples can rely on to increase their tax savings. If any part of the exemption amount is not used by the first spouse to die, the surviving spouse’s estate can use it. Say you die and only use $3 million of your exemption amount; your spouse now has an exemption amount of $7 million (her $5 million plus the $2 million that you didn’t use).

If part of your estate is taxable, the rate is only 35 percent—the same maximum tax rate for income tax on individuals and regular corporations. The estate tax rate in 2011 had been scheduled to be 55 percent.

Assets inherited before 2013 enjoy a “stepped-up basis” for income tax purposes, so that the heirs’ basis is the property’s value for estate tax purposes. Say you purchased stock years ago at 50 cents a share that is worth $5 per share when you die. Your heir’s basis in the stock is $5 per share; no one will ever pay any capital gains on your appreciation in the stock up to the date of death.

2. Do I still need to plan?

Probably yes. The favorable federal estate tax rules run only through 2012. No one knows what will be after that. For those with large estates, it’s advisable to work closely with a professional planner to devise plans that can be adapted if and when future tax rules change.

What’s more, even if you do not face any federal estate tax now, there could be an estate tax or inheritance tax on the state level. About half the states continue to impose their own taxes, often with much more modest exemption amounts. For example, New Jersey continues to have an exemption amount of only $675,000, so planning can be helpful to reduce or eliminate state-level taxes.

Even if you have not tax concerns, you need to make plans for special situations, such as children, especially in second marriages, and business interests.

3. What about my existing will?

If you signed your will before this year, you probably should have it reviewed by an attorney to make sure your wishes continue to be actualized in light of tax law changes. Problems can exist with older wills that were crafted with a much lower exemption amount in mind.

Take this case: When you wrote your will, you were married and had an estate of $5 million; the federal exemption amount at that time was $2 million and you included a trust that was to be funded with the maximum exemption amount. At that time, $2 million would have gone into the trust tax free; the other $3 million would have passed tax free to your spouse. Without any changes, if you die before 2013, all of your property will go into the trust and nothing will pass outright to your spouse. Is this what you wanted?

Don’t be quick to turn your back on the use of trusts. Even if no longer needed for tax savings, they still serve important non-tax functions, such as property management and keeping assets from heirs’ creditors.

4. My dad died in 2010, so what happens to his estate?

For estates of those who died in 2010, there is a special option: Use the new estate tax rules, combined with the stepped-up basis rule for heirs or use the rules that had been scheduled for 2010.

The 2010 rules that were to apply: no federal estate tax, regardless of the size of the estate, but a modified carryover basis for heirs. Under this carryover basis rule, up to $3 million in assets passing to a surviving spouse, plus $1.3 million passing to anyone, gets a stepped-up basis. Assets over these limits have a carryover basis, which means the heirs essentially step into the shoes of the decedent and take his or her basis. In the earlier example, carryover basis means an heir’s basis is 50 cents per share (what the decedent paid for the stock), rather than the stock’s value at death of $5 per share.

As a general rule, estates over $5 million would use the old rule to avoid any estate tax, while smaller estates would use the new rule to give heirs the better basis. Best strategy: Work with a tax professional to decide which option is better for your family.

What is Probate (or sometimes referred to as Estate) Administration?

Probate or estate administration refers to the process of probating the estate of a person who is deceased. A probate applicant ask the court to be allowed to “step into the shoes” of the decedent in order to be authorized to collect estate property, inventory and appraise the assets; pay or reject debts; file and pay estate taxes if applicable; and distribute any remaining assets to beneficiaries. Very often relatives of a decedent assume that a person’s estate transfers automatically to their heirs. This is not always true especially in reference to property. In order to sell land a person must have authority to convey title. A relative (no matter how close) is usually not automatically authorized to convey such interest. Further, banks and other financial institutions will not necessarily release funds to a relative once the account holder has passed away.

It is also important to note that when married couples pass away either simultaneously or at different times both estates may need to be probated. Often, it is assumed that we don't need to probate one spouses estate because assets automatically transfer to the other spouse. That is not always true. Further, it should be noted that the original will must be filed for probate administration within four years of a decedent's passing.

Having a will greatly simplifies the probate administration process. Without one, two hearings are generally required instead of one (Determination of Heirship and Probate Administration) and there is usually more court oversight which can make the process very expensive.

If you have any questions regarding the probate process please feel free to email your question to me. Further, there are many websites that now provide fairly detailed information related to the estate planning and the probate process. Try www.talbotlawfirm.com to start your search. We also have links to several other good websites.

Estate Planning: What Is The Best Way For You To Leave Your Assets?

Most people would like to leave a legacy to their heirs, whether it's money, a business, or a personal heirloom. In fact, many Texans may not realize that you don't even have to be a particular age to leave something for your spouse or children or if you wish to donate something to a special organization.

But the task many people are left with when it comes to estate planning is figuring out the best way they can leave their assets to their beneficiaries. And as most estate planning advisers and lawyers will remind their clients, you may need a will if you are planning to leave your wealth or personal property.

According to USA Today, an advantage for those who leave money in their will is that their heirs will not have to pay taxes on any appreciation that has accrued. For tax purposes, the beneficiary’s cost basis will be the value of the estate itself upon the decedent’s death.

Once the decedent’s debts have been paid, what is left of the assets becomes his or her estate, which is then subject to federal and state estate taxes (Texas currently has no estate tax). Other estate planning options to consider include:

•Setting up a testamentary trust, which is a trust that is created in your will and begins when you die. The assets remain as part of the person’s estate, so it’s still subject to estate taxes;

•Giving your children $13,000 this year, or $26,000 as a couple, if you want to leave them something while you are still alive without initiating any gift taxes. However, the recipient is subject to taxes if they receive shares of appreciated property, like stocks; and

•Creating a charitable gift trust or community foundation to donate to charity.

If you face a complicated or difficult estate planning decision, such as leaving a business to an heir, or just need guidance, consider seeking legal counsel from an experienced attorney.

Effect of Divorce on Estate Planning

A number of changes take place automatically when a person divorces. It’s important to know what those are, and of course it’s best to consider updating your estate plan after any major change such as marriage, divorce, death in the family, and so on.

Without knowing what’s in your will, let me tell you generally what happens.

Unless you clearly provide otherwise, divorce automatically revokes a number of aspects of your estate plan, including any provisions of your will favoring your ex-spouse, the designation of your ex-spouse as your agent under power of attorney and health care agent, and beneficiary designations favoring your former spouse. I’ll go through them one at a time.

Will – A divorce or (in some cases) pending divorce renders ineffective any provision of your will that favors, or even “relates to,” your Ex. A clause that gives him or her your entire estate is an example of a provision favoring your former spouse.

If you die while the divorce is pending, do those automatic changes take effect? That depends on how far along the divorce proceedings are. Generally, however if the divorce is not final your spouses interest would not be cut off.

Power of attorney (POA) – If you named your spouse as your “agent” in your POA, that part of your POA will be revoked. But the timing is different from what happens under your will. The POA change takes place as soon as either you or your Ex files for divorce.

Filing for divorce won’t nullify your POA entirely. If you named a successor agent after your former spouse (always a good practice), then that person could act as your agent and the rest of your POA remains intact.

Health care POA – If you have a health care power of attorney, as part of an advance health care directive or separately, a designation of your spouse as your health care agent would be revoked as soon as either you or Spouse files for divorce.

Beneficiary designations – You may have named your ex-spouse as beneficiary of a life insurance policy, annuity contract, pension or profit-sharing plan, or some similar contractual arrangement.

If you die, and you have such a beneficiary designation that you could have revoked, it will become ineffective in the same way as a will provision. That is, it would be ineffective if you were divorced when you died, or if grounds for divorce were established. However, you should know that some survivorship accounts will not be affected by a divorce and your Ex could still receive beneficiary proceeds on your death unless you change your beneficiary designation.

This same rule applies to any “conveyance which was revocable at the time of the conveyor’s death and which was to take effect at or after the conveyor’s death.” Certain deed provisions would fit this description.

When a beneficiary designation is ineffective, it would be as if ex-spouse died before you did. If you named a successor beneficiary, that is who would get the benefits.

If you have provided differently - Keep in mind that these changes won’t occur if your documents show that you wanted to keep provisions relating to your former spouse even if you were to divorce. A beneficiary designation could also survive depending on the wording of the designation, a court order, or a written contract between you and your Ex.

But if you did not provide differently, some of your estate planning provisions could end up being, well, terminated.