CERTAINTY OF DEATH AND TAXES

By Geraldine Barretto-Ko, Esq.

Have you ever heard the expression, “There are only two certainties in life: death and taxes?” But why do “death taxes” create such an uncertainty in those who are trying to plan their estate. What is a death tax and who needs to be concerned about it? Death tax, commonly referred to as estate tax, is tax imposed on a decedent's estate upon death, and it affects the wealthier portion of our population.

Individuals who die in 2006 leaving a taxable estate of over $2,000,000 are exposed to estate taxes. (Under current law, this amount increases to $3,500,000 in 2009, is repealed in 2010 and then it goes back down to $1,000,000 in 2011.) For 2005, that portion exceeding $1,500,000 will be subject to an estate tax at the starting rate of 39%, which tops at 48%. The taxable estate is generally determined by taking the gross value of the estate as of the decedent's date of death and reducing it by assets passing to the surviving spouse ( U.S. citizenship considered), gifts to charities, encumbrances, debts of decedents, and certain allowable deductions.

Because perception of ones wealth could be relative, it is best to be able to define wealth for those who are attempting to plan their estate. Clients seem quick to dismiss this issue by saying, I have nothing close to that amount. Clients tend to under-estimate their net worth because they forget about certain ownership interests or they do not realize exactly what is included in their taxable estate. One asset that is often not considered by clients in calculating their estate is life insurance. Life insurance proceeds will pass to beneficiaries free of tax but are included in the decedent's estate for the purpose of calculating the taxable estate.

One of the more common estate planning techniques used to avoid or minimize exposure to estate tax is the use of an A-B Trust. An A-B trust is a trust that requires the trustee to split the trust in two upon the death of one spouse, with each trust generally holding each spouses one-half share of the trust assets. To avoid paying estate taxes upon the decedent's death, his or her trust should only be allocated assets up to the maximum exemption amount, with the rest going into the survivor's trust. By allocating the decedents share into a separate trust, his or her lifetime exemption has been separated from that of the survivors and thereby preserved. Only the assets allocated to the surviving spouses trust will then be taxable upon the survivor's death - to the extent the estate exceeds that year's exemption amount. Therefore, this should be the trust that the surviving spouse should first deplete. The decedents trust must adhere to certain requirements and restrictions in order for it to be deemed completely separate from the survivors trust. The surviving spouse is entitled to receive any income that the assets allocated to the decedents trust generate, but the survivor should be given limited rights to the use of the underlying assets, that way, those assets that have been segregated will not be deemed owned by the surviving spouse and thereby included in his or her taxable estate. Furthermore, the decedents trust is a separate tax paying entity for which a return is due every year.

Clients are quick to dismiss their need for an A-B trust because its benefit does not seem real to them. My observation is that clients tend to focus on the rising exemption amount, instead of the sunset provision where the exemption amount goes back down to $1,000,000 in 2011. They feel that because of the rising exemption amount, they need not worry about estate taxes. Surely these clients are not planning to die in the next five years, so why are they only focusing on the exemption amount for those years? The challenge lies in the uncertain. Clients want the comfort of knowing that the estate plan they choose is guaranteed to protect them but at the same time, they want the satisfaction of knowing that they did not waste money or energy in choosing an unnecessary estate plan. As a practitioner, I have found it challenging to convince a client that an A-B trust will serve them best. They are often skeptical that lawyers are after additional fees or that lawyers are trying to complicate matter for them. That is not the case. Everything is a tradeoff. To avail the tax benefits of an A-B trust, clients would have to deal with its requirements. In the long run, clients definitely come out ahead.

Of course, no one could ever predict death nor can anyone predict how Congress will later address the estate tax rules. However, some plan is better than no plan, and living trusts can always be amended as the law changes.

If you are interested in learning more about estate planning and its benefits, Marquis & Aurbach will be hosting a free educational seminar on January 26, 2006 at 5:30 pm at our law firm. Please call Kelly Behrens at 821-2409 to confirm your attendance.