39.10 Planning for a Potential Estate Tax
Estate tax planning has been complicated by short-term legislation that creates uncertainty over what the rules will be in upcoming years (39.9). However, if you have substantial assets so that estate tax is a possibility for you, there are general approaches that you can take to reduce or eliminate a potential estate tax.
You can make direct lifetime gifts. Any appreciation on the property transferred will be removed from your estate. Furthermore, each gift, to the extent of the annual per donee exclusion (39.2), reduces your gross estate (39.9). Life insurance can be assigned to avoid estate tax, provided the assignment takes place more than three years before death (39.8). You can provide in your will for bequests that will qualify for the marital and charitable deductions.
The marital deduction.
A married person may greatly reduce or eliminate estate tax by using the marital deduction. Property passing to a spouse is generally free from estate or gift tax because of an unlimited marital deduction.
Weigh carefully the tax consequences of leaving your spouse all of your property. For maximum tax savings, you may want to give your spouse only enough property to reduce your taxable estate to the applicable exemption amount (39.9). The unified credit amount will then eliminate tax on that amount at the time of your death. By leaving your spouse less than the maximum deductible amount, you may be able to reduce the estate tax at the time of his or her death. However, this may become less of a concern if exemption portability (39.9) is extended permanently.
Planning Reminder
Life insurance proceeds may qualify as marital deduction property. Name your spouse the unconditional beneficiary of the proceeds with unrestricted control over any unpaid proceeds. If your spouse is not given this control or general power of appointment, and there is no requirement that proceeds remaining on your spouse’s death be payable to his or her estate, the insurance proceeds will not qualify for the marital deduction.
What should be done if you believe your spouse cannot manage property? You will not want to give complete and personal control. The law permits you to put the property in certain trust arrangements that are considered equivalent to complete ownership. Your attorney can explain how you can protect your spouse’s interest and qualify the trust property for the marital deduction.
Marital deduction restrictions for noncitizen spouses.
A marital deduction may not be claimed for property passing outright to a surviving spouse who is not a U.S. citizen. However, the marital deduction is allowed if the surviving spouse’s interest is in a qualifying domestic trust (QDOT). At least one trustee must be an individual U.S. citizen or domestic corporation with power to withhold estate tax due from distributions of trust corpus. The trust must maintain sufficient assets as required by IRS regulations. For the marital deduction to apply, the executor must make an irrevocable election on the decedent’s estate tax return. On Form 706-QDT, estate tax will apply to certain distributions of trust corpus made prior to the surviving spouse’s death, and to the value of the QDOT property remaining at the surviving spouse’s death. You should consult an experienced tax practitioner to set up a QDOT trust and plan for distribution provisions.
Caution
The estate of a nonresident alien is subject to estate tax only to the extent that the estate is located in the United States. A marital deduction may be claimed by the estate of a nonresident alien for property passing to a surviving spouse who is a U.S. citizen. If the surviving spouse is not a U.S. citizen, then the transferred interest must be in the form of a QDOT.
Family-owned business interest deduction.
Starting in 2013, there is an estate tax deduction of up to $675,000 for an interest in a family-owned business. A family-owned business means ownership of at least 50 percent by one family, 75 percent by two families (with the decedent’s family owning at least 30 percent), or 90 percent by three families (with the decedent’s family owning at least 30 percent).
State death taxes.
The deduction for state-level estate or inheritance tax (“state death tax”) that has applied since 2005 expires at the end of 2012. Starting in 2013, instead of a deduction, an estate can claim a limited tax credit for state death taxes.
Periodically review your estate plan.
No estate plan is ever really final. Economic conditions and inflation constantly change values. For this reason, your plan must be reviewed periodically as changes occur in your family and business, as when a birth or death occurs; when you receive a substantial increase or decrease in income; when you enter a new business venture or resign from an old one; or when you sell, retire from, or bring new persons into your business. A member of your family may no longer need any part of your estate, while others may need more. Material changes may occur in the health or life expectancy of one of your beneficiaries. Furthermore, tax law changes may require you to adjust your estate planning,