Sunday, November 21, 2010

Estate Taxes 2010 and After?

I offered a couple days ago to post a an article about current outlook for estate taxes. I found this article very informatice. and appreciated the flow chart linked halfway down the page. I copied the article from a website name Business Java

Estate Tax for 2010 – Still No Change

About The Author
Joe Arsenault
Joe Arsenault is a CPA in the state of Arizona. Joe has a tax background and specializes in consulting in the field of retirement and pension taxation for Shurwest Financial Group. Joe is the founder and administrator of Cafetax.

Everyone expected that in 2010 Congress would reinstate the estate tax. Not many people seemed to have the opinion that we would be half way through the year looking at a real possibility of having no estate tax for 2010. Of course as good as an estate tax free year seems, 2011 goes back to the exemption amount of $1 million with a 55% tax rate. Not the friendly $3.5 million of that existed in 2009. There may also be some serious traps for the unprepared, discussed at the end.

I have been getting a lot of questions that are along the lines of..

What will happen if there is no estate tax?
What are the gifting rules in 2010?
What are the basis rules, I heard my clients will not get a step-up in basis?
How will this affect the funding of Bypass trusts since there is no applicable credit?

Unfortunately there really isn’t a simple answer, but if you want one, well… If there is no applicable credit and estate tax, anyone who dies this year will not be subject to estate tax regardless of the size of their gross estate. Of course the ugly truth is, there are many complicated facets to every estate and improper planning will negate any potential benefits of a 0 estate tax year.

Interestingly enough, even without an applicable credit, the $1 million dollar exemption for lifetime gifts that became permanent in 2003 is still in force. One thing did change, the top gift tax rate is only 35% this year. This alone opens up major possibilities for some clients and estates.

As far as the basis rules, I will cover that in another blog. The simple answer is that heirs will receive a total of $1.3 million in basis credit to step up ELIGIBLE appreciated assets. Any estate with over $1.3 million of built in gain will essentially hit the heirs. Otherwise, assets will be valued at the lower of fair market value or basis for beneficiary inheriting the asset.

The last question is the big dog for this blog. What about the Bypass trust? This is where you must focus and be very diligent and flexible with your estate planning and trust work. If a spouse died in 2009 with a sizable estate, it is very common that a provision in their living trust funded the assets into an ‘A’ trust and ‘B’ trust.

The ‘A’ trust is the marital trust that allows the spouse to fully inherit the assets while utilizing the unlimited marital deduction so the first deceased spouse does not have to include the assets in their gross estate. The ‘B’ trust is commonly referred to a Bypass Trust or Credit Shelter Trust. The assets in this trust are included in the first spouse’s estate but not the surviving spouse’s estate. So in 2009, if $3.5 million is funded in the ‘B’ trust, that maximized the gross estate without triggering tax because the applicable credit was $3.5 million, and removes $3.5 from the surviving spouse’s estate.

Below is a pdf of a flow chart I created that illustrates this concept in the most simple form. Assume a community property state where the living trust funds the A/B trust by 50 percent each. Note that this is hypothetical and simplified.

Fact pattern applied to flow chart:

$5 million dollar gross estate (asset type ignored for simplicity)
First spouse passes away
Trust is funded with full $5 million and split 50/50 between A and B trust
Bypass trust becomes funded with $2.5 million and grows outside of surviving spouse’s estate
Marital trust becomes funded with the other $2.5 million, spouse has full rights and amount will be included in their estate, including appreciation during his/her life.


Ok, so what happens in 2010 if there does not end up being an applicable credit and estate tax? Essentially, any amount passing through your estate does not have a transfer (estate) tax, even if its say $10 million. This creates an interesting dynamic for the Bypass trust. Bypass trusts are used to maximize the applicable credit and shelter assets from the surviving spouse’s estate, but there is no applicable credit! Two major issues arise and it all has to do with the wording of the trust instrument and how they are directed to fund.

There is a major risk that if your trust directs the Bypass trust to be funded with the maximum amount allowed to be passed free of estate tax you could COMPLETELY DISINHERIT YOUR SPOUSE. While the spouse may be an income beneficiary, they do not receive the remainder interest and have no power to change who does. If the trust is worded improperly, you could have a situation where your entire estate funds in the Bypass trust and the spouse is locked out.
On the opposite end of the spectrum, one may want to take advantage of not having estate tax this year and pass as much as possible through the estate transfer tax free. Sometimes the bequest language use phrases like “applicable credit exemption”. Well there is no applicable credit, so if nothing funds in the Bypass trust, the surviving spouse may be taxed much harder in the future. You lost your one year opportunity to transfer assets free of tax to another generation. Lets say in a non-community property state the spouse only needs 25% of the assets and 75% will go to the kids. In a $10 million dollar estate that is $7.5 million that may be removed without a transfer tax.
The type of assets in your estate and the built in gains are a very important aspect of this planning that I am not going to discuss. This may not be a concern in 2010 with a limited $1.3 million dollar basis step-up which is a large part of the planning. In any event, there is usually a balance between utilizing the applicable credit, the gifting during your lifetime and basis step-ups for eligible assets.

If you have a living trust and estate concerns, you should have your trust reviewed by a CPA or attorney. You may need to change the language in your trust to ensure that your intentions are properly carried out if you pass away in 2010. Even if you don’t, the landscape is currently invisible and a good review would be wise. Important planning can leave your spouse and heirs with a much larger chunk of your estate.

Remember, your situation is unique. You need a professional review if you think this applies to you.

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