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Avoiding Death Taxes
By David G. Hoffman, J.D.
For the most part, the Federal Government collects its
revenue in one of two ways, incomes taxes and transfer
taxes. Although we have only one income tax, we have two
transfer taxes: the Gift Tax and the Estate Tax. Most of us
will never be so generous as to incur a Gift Tax. However, a
very large percentage of Americans will pay the Estate Tax
or, to be more precise, their children will pay the Estate
tax.
In a nutshell, the Federal Estate Tax is a tax on death.
Here is how it works. When you die, the IRS adds up the
value of everything you own or in which you had even a
partial ownership. That total is called your Gross Estate.
Your Gross Estate is then reduced by deductions for
charitable bequests, debts and final expenses to arrive at
your Taxable Estate. If your Taxable Estate is less than 2
million dollars, there is no tax. If your taxable estate
exceeds 2 million dollars, the excess is subject to a tax
rate of 46%.
Now before you scoff at the very notion of being worth two
million dollars, you should know that the IRS bases their
valuation on some things that you may not have considered.
For example, your life insurance is counted as part of your
Gross Estate. (It is true that life insurance is not subject
to the Income Tax but it is subject to the Estate Tax.)
Also, you must add in the vested portion of your 401K or
other pension plans. As for your home or other real estate,
you must use the current market price and NOT the county
real estate assessment. And if you own a small business,
well, there are no clear guidelines for exactly how to value
that. Inheritances, as well, are added into the total. If
after all of this figuring, you find that your Taxable
Estate is anywhere near the 2 million dollar threshold, you
should probably do a little Estate Tax planning.
The simplest and most reliable way of avoiding the Estate
Tax is by use of a Credit Bypass Trust. This form of trust
doubles the 2 million dollar Estate Tax exemption for
husbands and wives. In other words, with a Credit Bypass
Trust, the Estate Tax does not apply until you and your
spouse have a Taxable Estate in excess of 4 million dollars.
In addition to the Credit Bypass Trust, couples and singles
alike can use a Life Insurance Trust. Put simply, a Life
Insurance Trust eliminates the Estate Tax on your life
insurance proceeds. And, if you own a home, a Qualified
Personal Residence Trust will magically reduce its value for
Estate Tax purposes. In fact, thanks to the creativity of
lawyers, accountants, senators and congressmen, there are a
myriad of trust arrangements that can be employed to save
your children literally hundreds of thousands of dollars in
Estate Taxes.
But then again, perhaps you have heard that the Estate Tax
is being repealed. It is true that under current law, the
Federal Estate Tax is being phased out. For 2006, 2007 and
2008, Taxable Estates worth less than 2 million dollars will
be exempt from the Estate Tax. In 2009, the exemption
increases to 3.5 million dollars. In 2010, the Estate Tax is
repealed entirely. But then, in 2011, the Estate Tax returns
with an exemption of 1 million dollars. Of course, this
so-called repeal may itself be repealed if the Democrats
regain control of Congress.
Not to be left out, almost all of the States have their own
death taxes. State death taxes come in two varieties, the
state estate tax and the state inheritance tax (some states
have both). For the most part, state estate taxes are
identical to the Federal Estate Tax, with two important
differences: (1) the state estate tax is usually much, much
lower; and (2) most states have absolutely no plans for
repeal.
State inheritance taxes, on the other hand, are based on
your relationship to the deceased. Spouses and children pay
little or no inheritance tax while distant relatives may pay
as much as 90%. In other words, if you dream of being the
long lost heir of a distant relative, just remember that
your state shares in your fantasy.
You and your family may, in fact, never have to pay a death
tax. Nevertheless, you must consider the possibility since a
death tax can be a truly staggering sum. As the old saying
goes, hope for the best but plan for the worst. Or as one
client put it, “I want to be sure to leave my money to the
kids but disinherit the government.”
David Hoffman is a Virginia attorney who limits his practice
to wills, trusts, probate and estate taxation. His offices
are located in the northern Virginia suburb of Fairfax City.
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