The estate planning process can be a mine field for the uninformed. The process of estate planning involves the coordination of the various assets of an individual into a cohesive, comprehensive plan to provide for family members. The real trick here is to analyze all assets whether held individually, jointly, and those that pass by beneficiary designations to come up with an effective overall and integrated strategy to deal with these assets. In many cases assets are incorrectly titled and need to be realigned. Often times beneficiary designations for life insurance and retirement plans need to be changed to obtain better tax and estate plan results.
The following are some of the common mistakes or misconceptions in this area, along with related estate and tax planning strategies to address these issues and to improve a client’s tax posture.
The failure to draft a will results in the following problems or disadvantages:
Although what may have seemed a good idea and was the natural inclination of most married people, leaving everything to your spouse was not a good idea under prior law. Where a decedent had a will that simply gave everything to the surviving spouse, under the old tax rules they would have failed to utilize their exemption. When the second spouse died they included in their estate the assets received from the first spouse to die. Before the “portability” rules were enacted, the the exemption of the first spouse to die could not be utilized at the second death of the surviving spouse.
To correct this problem, federal laws were enacted that allow for the “portability” of the first spouse’s exemption. These new portability rules allow for the second spouse to use the first spouse’s unused exemption.
As a result, portability allows for the full utilization of both spouses unified credit in most cases. However, there are some important limitations and special rules that may limit the value of portability. Here are some portability rules to keep in mind:
This is a lot to consider, so where does this leave most taxpayers? In certain circumstances, taxpayers will want to insure that they are able to utilize their unified credit exemption regardless of what the surviving spouse does. In such a case, they can eliminate estate taxes by placing their assets in a credit shelter trust. If correctly structured, the unified credit trust can also provide the surviving spouse and/or descendants with income for life and access to the principal as needed, but the assets will pass free of federal estate taxes. The savings here could be quite significant and the planning is much more certain. Finally, using this mechanism combined with GST tax exempt trust provisions can accommodate a client who wishes to create a dynasty or generation skipping trust.
In families where things are more predictable, it may be feasible to still leave assets to the surviving spouse and relying on the portability rules to minimize or eliminate federal estate taxes, but subject to the risks and limitations discussed above.
Where assets are more modest in amount, federal estate taxes may not currently be a concern. Be aware that for 2020, the unified credit (exemption from tax) is $10,580,000 for any decedent. The amount of course is doubled for a married couple. This would exempt most taxpayers from a federal estate tax. But be aware that the new administration may need to decrease this exemption amount as a result of the mounting federal deficit and the massive costs of the pandemic. This would result in more complicated planning for most taxpayers.
Although jointly help property can be easy to establish, the following are some issues to consider when holding assets in this way:
Naming the beneficiary of a life insurance policy seems simple enough but as they say “the devil is in the details.” Where a husband and wife suffer a simultaneous death and small children are named as contingent beneficiaries of the life insurance proceeds, an expensive and time consuming probate court procedure will be needed to appoint someone to administer the policy proceeds. The person the court appoints as trustee may not be the person the deceased parties would have chosen. This could be a very expensive and problematic situation. By drafting a trust and having the trust named as the contingent beneficiary and not young children solves this problem.
Second Marriages: Where a second marriage is involved and the second spouse is named beneficiary, these proceeds may never end up benefiting the deceased spouse’s children.Once again a trust could be drafted to receive the insurance proceeds and to provide for both the surviving spouse and children from the first marriage.
Federal Estate Tax: From a federal estate tax perspective, people are surprised that life insurance owned by an individual is included in their taxable estate at death. This may result in federal estate taxes being paid on insurance proceeds at death.
Taxpayers sometime fail to recognize they can give $15,000 per year to as many donees as they desire. In addition, the spouse can join in such gift for an additional $15,000 annual donee exclusion. This will allow for gifts of $30,000 per year to as many donees as desired. Note that this gift must be a present interest gift as defined by the Internal Revenue Code, regulations and case law. Basically, a present interest gift is one where the recipient can enjoy the immediate benefits of such a gift in a significant way. In addition, a taxpayer has a unified credit of $10,580,000 to utilize against lifetime gifts. For more on this topic, related and other gift strategies please review Gift Giving: Tax Advantages.
There are other gift giving strategies that may be available depending upon the situation. For example, the use of a family limited partnership can be a powerful transfer vehicle that can create estate and income tax savings for a family. Please see the article Family Limited Partnerships to explore these tax benefits.
Gifting of shares in a closely held business to those involved in a family business can be quite advantageous especially if the value of such shares are currently depressed due to the current financial conditions. For using tax strategies such as minority interest and lack of marketability discounts and how they create tax advantages in a bad economy please read my article Gifting Shares of Stock In A Bad Economy that was published in the Tax Corner section of the Journal of Accountancy in September 2009.
Depending on the situation other gift giving strategies such as the following may be utilized:
The above are just highlights of some mistakes that can occur without proper planning. The reality is that any estate plan must be tailored to the client’s family needs while taking gift, estate and income taxes into account. The special financial needs of family members also need to be considered. Blended families and second marriages raise special practical, legal and tax considerations.
Bringing together a person’s diverse assets to fit into an integrated and comprehensive estate plan that results in wills, trusts and other documents that actually work as intended is at the heart of sound estate planning.
Steven has been providing outstanding legal advice to me for seventeen years. He is THE authority on estate planning and financial planning. Steven is a compassionate and thorough attorney who thinks of every possible contingency. He easily explains complicated issues, and it has been my pleasure to recommend him to my friends.