Usual Suspect Number Two: Estate Tax

Hypothetical Conversation with an IRS Agent

• IRS Agent: We want the wealthy to pay a greater share of tax to the government. Therefore, we will tax a portion of everybody's assets at their death which is above a certain amount. This amount will be called the "unified credit limit." Also, the rate that you will be taxed at is just under fifty-percent (Note: The "Unified Credit Limit" is currently $3,500,000, but it is soon to be only $1,000,000).

• You: Really?!? So if I died in 2011, as it stands my wife will have to give nearly half of my assets, that are over one million dollars, to the federal government when I pass away?

• IRS Agent: Yes, but we'll make an exception. Any assets which transfer to your spouse at your death do not count in this calculation, so if you give everything to your spouse, or everything but one million dollars to your spouse, then there is no tax. (Note: This is the "Unlimited Marital Deduction") But, after her death, she will die with your combined assets and she will be taxed on the entire thing!

• You: That is horrible! Fine, I will just transfer all my assets to my children on my death bed while I am still alive, and then tell my wife to do the same, then it won't be ours at death and it won't get taxed!

• IRS Agent: Not so fast. You can only give a certain amount each year to any one person, or else the excess will be taxed, or be counted against you at your death in our Estate Tax calculations. (Note: This is the Gift Tax. During your lifetime, you can currently give $13,000 to as many individuals as you want each year. Two spouses can give a total of $26,000/year to as many individuals as they choose.)

• You: So each year I can give $13,000 to my son Jeff, $13,000 to my daughter Ann, and $13,000 to my other daughter Rebecca. My wife can also do this? So, each year we can together give $78,000 to our kids and reduce our estate for Estate Tax purposes at our deaths?

• IRS Agent: Yes, you can do this, every year.

• You: Well that helps a little . On second thought, maybe I'll just wait and get taxed at my death, but I'll just give only a little to my kids, and I will just give the remainder to my grandkids so my kids do not have to deal with this when they are older and considering their own Estate Plan.

• IRS Agent: That won't work. We want your legacy to be taxed at each step. To discourage this, we add an additional tax to the Estate Tax if you skip a generation and give assets directly to your grandkids. (Note: This is the Generation-Skipping Transfer Tax.)

• IRS Agent: Sorry, that is the way it works.

• You: Ugh. Another question, are you saying that if I died today with under $3,500,000 I will have no tax, and amounts transferred to my wife do not count. Does that mean I can give her everything but $3,500,000, and instead give that to my kids, and pay zero Estate Tax?

• IRS Agent: Yes, you are right. That would work if you passed away in 2009! But, remember that in 2011 the new limit is $1,000,000, and not $3,500,000!

• You: Okay. I have another question. Is there any way that I can give my wife access to ALL of my funds, just in case she gets sick, with an expensive, debilitative disease, or some other emergency. Also, what if I don't want my kids to have access to those funds until my wife passes away?

• IRS Agent: We will meet you in the middle on this one by letting you store $3,500,000 in assets at your death. Your wife can then use the income (such as rent or interest) from those stored assets in any way that she wants, but she can only use the principal of those assets for her own care if required for her health, education, support and maintenance. (Note: This is the entire point of a Disclaimer Trust or the AB/Bypass/Credit Shelter Trust!)

• You: Right, and these sheltered assets won't affect her Estate Tax at her death?

• IRS Agent: Correct, and at her death she will not pay tax on the first $3,500,000 she owns as well, or whatever the unified credit limit is on the year of her death.

• You: So with the correct planning, me and my spouse could keep $7,000,000 from being affected by the Estate Tax?

• IRS Agent: For the most part. The unified credit limit changes each year, and the one that would affect you is the one that is in existence at your death. If you died this year, where the unified credit limit was $3,500,000, and then you wife died in 2012 when the unified credit limit would be $1,000,000, then you could only save $4,500,000 from being taxed.