Wood Law Firm - Feature Articles - Basic Estate Planning

The Need for a Will
A will is an instrument which passes title to property at death. A person who dies with a will dies testate and a person who dies without a will dies intestate. Wills have many functions, some of which we will examine here.

When a person dies without a will, the intestacy laws of Florida, South Carolina and the District of Columbia determine who from among his or her family inherits the property and in what proportions. On the other hand, a person who leaves a will is free to name his or her own beneficiaries and indicate the amount passing to each beneficiary (except that the will cannot terminate the surviving spouse's right to an "elective share" of 30%-33% of the estate).

A will can be used to place funds in trust for the benefit of minors or others unable to manage property given outright. This "testamentary" trust can be used, for instance, to educate children and ultimately be distributed to children at whatever age or ages the testator wishes. On the other hand, property passing by intestacy is distributed to the heir immediately or, for minor heirs, upon reaching age 18.

A will may also be used to express a desire as to who should be appointed as guardian of the testator's minor children.

A will is a unique opportunity for a person, during his lifetime, to designate who will take charge of his affairs after his death. This opportunity should not be taken lightly. If not exercised by the testator, it will be exercised by a judge. The person or bank in charge of the estate is called a personal representative. The functions of a personal representative include gathering all the decedent's property, following the instructions of the will, paying taxes, claims against the estate and administration expenses, paying bequests under the will, safeguarding the interests of the beneficiaries, and closing the estate. The person in charge of a trust is called a trustee. The trustee may be either an individual or a bank.

A will may be used to specify the source from which taxes, expenses, claims and other charges against the estate are to be paid.

Finally, a will may also be used to take advantage of estate tax deductions and exclusions.

Revocable Trusts
Just as a will may contain provisions to utilize various tax vehicles as well as address family concerns, so too may a revocable (or "living") trust be useful in this regard.

Unlike a will, which takes effect only at the death of the testator, a trust takes effect at the time of its creation. A trust is a contract between a grantor (sometimes referred to as the settlor) and a trustee. The contract - or trust agreement - contains a list of instructions to the trustee concerning disposition of property transferred to the trustee. For example, the trustee may be required to pay all income to the grantor during the grantor's life, place the property in an estate tax deferred trust upon the grantor's life, place the property in an estate tax deferred trust upon the grantor's death, and finally distribute the trust property to the grantor's descendants upon the death of the grantor's spouse.

Revocable trusts, because they take effect during life, have various advantages:

Estate Taxes
Estate tax is the federal government's tax on the value of property passing from a decedent to beneficiaries. The government allows us to transfer property to whomever we wish at our death. It taxes our estates, however, for that privilege. This tax is assessed against the fair market value of all property owned by the decedent at death.

The gross estate is made up of all property of the decedent: real estate, personal items such as automobiles, jewelry, household furnishings, stock, bonds and royalties - everything, tangible or intangible, wherever situated. In addition to individually owned property, the estate also includes jointly owned assets, accounts "in trust for" others, most life insurance policies, transfers with retained interests, property in revocable trusts, property subject to certain powers of appointment and certain transfers made for insufficient consideration. The estate tax is calculated on the "taxable estate," which is the gross estate less deductions and exclusions, discussed below. The tax rates range from 18% (taxable estates under $10,000) to 45% (taxable estates over $3,000,000). Because the rates are high, it is important to fully understand and consider utilizing the various aspects of estate taxes. These include especially the marital deduction and the unified credit against estate taxes.

Marital Deduction
When calculating the taxable estate, an unlimited deduction is allowed for property passing from the decedent to his or her surviving spouse. Use of the marital deduction should be considered by all married individuals with potentially taxable estates (over $2,000,000) since it affords the opportunity to avoid estate tax on the death of the first spouse. Property may be transferred to the surviving spouse in a variety of forms: by outright gift under a will, by right of survivorship in jointly owned property, by contract (such as life insurance or IRAs) or under a trust. A trust qualifying for the marital deduction may be either created during the decedent's life or by will at death. A marital trust must provide that the surviving spouse is entitled to all income from the trust, payable annually or more often, during the surviving spouse's lifetime. The trust must either give the spouse an unlimited power to appoint the person or persons to whom the trust property will be distributed at the survivor's death, or may be in the form of a Qualified Terminable Interest Property ("Q-Tip") trust, under which the testator pre-determines the recipients of the property following the survivor's death.

No estate tax is incurred on marital deduction property in the estate of the first spouse to die, but any property not consumed or otherwise disposed of is taxable in the estate of the survivor. Therefore, it can be said that use of the marital deduction merely results in deferral of estate tax. This deferral can be very beneficial where the surviving spouse lives for some time and has available the additional property without tax. The trade-off for this deferral, however, is that in cases where unconsumed property appreciates, the estate tax at that later date will be based on the appreciated value of the property.

Charitable Deduction
Just as property passing to a spouse is deductible from the gross estate, so also is property passing to a qualified charity. As with the marital deduction, there is no limit on the amount of deduction allowed. A charitable donation may take many forms. It can be given to a charity outright or in trust. The trust may be for the sole benefit of charity or partially for charity and partially for your beneficiaries (a "split interest" gift). Split interest gifts take the form of charitable remainder trusts (in which an individual receives income for a term of years or for life and, at the end of the term, the balance of the trust is paid to the charity you name) or a charitable lead trust (in which the charity receives income for a term of years and, at the end of the term, the balance of the trust is paid to the individual you name). In the case of the charitable remainder trust and the charitable lead trust, a partial estate tax deduction is allowed for the interest given to charity.

As with the marital deduction, the full advantages of the charitable deduction may be obtained through the use of either a will or a revocable trust. This is especially the case with persons who either are not married or who have estates which would otherwise be taxable and wish to save estate taxes.

Unified Credit
Bequests to spouses and charities are deducted from the taxable estate. The unified credit, on the other hand, is applied to reduce the tax itself. This credit (called "unified" because it also applies to lifetime gifts) is currently in an amount to eliminate estate taxes of $2,000,000 worth of property. (This tax relief is being increased by the Economic Growth and Tax Relief Reconciliation Act of 2001 to $1,000,000 in the year 2002 and gradually to total repeal of the Estate Tax by the year 2010.). The problem with the new act is that the old scheme of taxation is reintroduced in 2011 to what the law was before the 2001 act. This means that in the year 2011 Estates of $1,000,000 and greater will again be taxed .

The proper utilization of the unified credit can provide a quantifiable and substantial benefit. For example, assume as illustrated by Figure 1 on the next page, John dies in 2007 leaving an estate of $2,500,000. His will leaves his entire estate to his spouse. She has no separate assets. On John's death, his estate receives a marital deduction for the full $2,500,000 passing to his spouse. However, on his spouse's later death (also in 2007), she will pay tax on a taxable estate of $500,000.

Assume instead that John, by his will (or trust) places $750,000 in a trust which pays income (and principal, if needed) to his spouse during her life and, upon her death, is distributed to their children. Assume the balance of John's estate ($750,000) is to be distributed to his spouse. The estate tax consequences in John's estate are the same as in the previous example. The difference occurs in the spouse's estate. There, at her later death, her estate will be comprised only of the $750,000 she received from her husband. John's other $750,000 is in the credit shelter trust and is not owned by his spouse. Since she is left with less than $2,000,000 her estate tax is also zero. Therefore, $250,000 in estate taxes has been saved.

Generation Skipping Transfer Tax
Generally, when a person transfers property to his child, the transfer is subject to gift or estate tax. Likewise, property passing from that child to his child is also subject to a gift or estate tax. However, a transfer from a person to his grandchild is subject to a gift or estate tax and generation-skipping transfer tax.

The generation-skipping transfer ("GST") tax is a separate tax designed to prevent the avoidance of gift or estate tax which would have been payable if the property had been transferred first to the intervening generation and then transferred to the grandchild. Current law subjects generation-skipping transfers to this tax at a 55% rate, regardless of the size of the transfer.

Each individual can transfer, however, up to $1,000,000 of property, free from GST tax. This $1,000,000 exemption is similar to the $1,000,000 unified credit exemption.

Using proper planning, a husband and spouse can shelter $2,000,000 from GST tax. Since generation-skipping transfers are taxed at a flat 55% rate, the tax savings achieved by use of both exemptions is $1,100,000. There are also a number of ways by which the $1,000,000 exemption can be leveraged, resulting in even greater savings, for example, by using a transfer designed to achieve multiple skip.

Some Problems Presented by the new Economic Growth and Tax Relief Reconciliation Act of 2001
You may need to have your estate plan reviewed. Most plans are drawn putting the Unified Credit Equivalent amount ($2,000,00 in 2007) into a credit shelter trust. If your beneficiaries are your spouse and children and everything over the Equivalent amount goes to your spouse, the slowly increasing amount of the exemption, may not present a problem because your spouse may get income from both portions of your estate.. However, suppose that you have made only your children the beneficiaries of the credit shelter trust, as the credit increases, so does the amount that is subject of the credit shelter trust. If you have an estate of $2,500,000, then the credit shelter trust gets $2,000,000 in 2007 and your spouse gets $500,000. This result usually is not be what you want. There are several ways to make sure that your spouse has the funds he or she needs while guaranteeing remainders go down to your children.

RECOMMENDATION: Review your estate plan as soon as possible, to determine if the amounts going into the credit shelter trust and the marital portion follow your intentions. You may either have your spouse's portion underfunded or overfunded by your present plan.

*For 2010, the gift tax rate will equal the top individual income tax rate under the Act, which is 35%.

Fidelity, the biggest mutual funds dealer, has a website with excellent tools for estate planning. These tools include an estate planning guide, an estate calculator, an estate planning checklist and a recent publication called "Estate Planning Outlook Special Report". Go to Fidelity.com, choose the "Retirement & Guidance" TAB and then the Estate Planning option. (This link will open in a new browser window. Close that window to return to this site.)