San Francisco Examiner: Business Section, Tuesday, March 21, 1995


Strategies to minimize estate taxes

(Second of two parts)

DURING YOUR lifetime, you may have acquired a house, possibly a second residence, own stocks and bonds, have funds in savings, and even socked away money in retirement accounts. Upon your death, these assets will go to your spouse and eventually to your kids -- or whomever you want. Or will they?

Lurking in the background is Uncle Sam, who is licking his lips at devouring a chunk of your estate. Over the next 20 years, between $7 trillion and $10 trillion dollars in potential estate value might be "up for grabs." Competing parties for your estate will be your beneficiaries, the IRS and the probate industry (attorneys and professional executors).

Last week, I presented ways to avoid probate when you transfer your assets at death. This week, I will discuss four estate planning concepts to minimize -- or completely eliminate -- estate taxes and potential income taxes to the beneficiaries.

A person may make a gift of cash or property worth $10,000 per year, per recipient ("donee"), without incurring a federal gift tax. (California has eliminated both gift and estate taxes). For a husband and wife, the amount is $20,000 per year, per donee. To qualify, the gift must be completed; ;the gift cannot be placed in trust unless the beneficiary has the right to withdraw it within a reasonable period after the gift is made.

For example, if a brother wants to give gifts to his sister, good friends, and his three children, he may give $10,000 in cash or property to each, all in the same year, without incurring any gift tax. By making annual gifts, the brother is lowering the value of his estate. As we will see later, if the brother's estate at death is less than $600,000, then no estate tax will be owed.

Property that has not appreciated (increased in value) makes an ideal gift, since the beneficiary receives the same tax basis in the property as the donor had.

Estate tax

The federal estate tax is a tax levied on all property owned by the decedent at death. The tax is paid by the estate for "the privilege of passing property to the beneficiaries."

The tax is based on the property's fair market value at the date of death or on the alternate valuation date (see below).

A person's assets are valued at fair market value by the person (executor of the will or trustee of the living trust) filing the federal estate tax return upon death; however, an alternative valuation date of 6 months after death is available for estates that have decreased in value.

The tax basis of the decedent's property is "stepped-up" from the old lower value to the new higher value (presumably) to determine the estate tax.

Tax basis is usually the cost of the property plus improvements and less any depreciation. For example, if the decedent dies owning stock that he or she originally purchased for $5, but at death has a current value of $100, the $100 value is used to determine the estate tax. The stock then receives a new stepped-up basis of $100 in the hands of the beneficiary.

No income tax will need to be paid later if this beneficiary sells the stock for $100 or less; income tax would have to be paid on the sale of stock only for an amount in excess of $100 and only for that excess amount.

With community property, even thought 50 percent passes outright to the surviving spouse, both halves of the community property receive the new stepped-up basis upon the death of the first spouse.

"Unified credit"

Each person is entitled to a lifetime credit worth $600,.000 for gift and estate taxes called the "unified credit." This total credit does not include the $10,000 annual gift tax exclusion discussed previously. If a person makes a single annual gift to a single donee of $50,000, then the additional $40,000 -- which does not qualify for the annual gift tax exclusion -- will reduce the donor's lifetime unified credit from $600,000 to $560,000.

The unified credit may be applied toward property left to any donee, either outright or in trust. Often, a married couple uses their unified credits to create two separate trusts. Each establishes a $600,000 trust that provides the surviving spouse with income from the trust during his or her life. Upon the surviving spouse's death, the children then become beneficiaries of the trust. This trust is sometimes called an "exemption trust" or a "bypass" trust since it is totally exempt from estate taxes, upon the death of either spouse.

The unified credit plays a major role in estate planning because there is no estate tax for estates valued at less than or equal to the unified credit.

Marital deduction and Q-TIP trust

The marital deduction can be extremely complicated, but represents the most important deduction available to married couples whose estates exceed $1.2 million.

The decedent's gross estate can deduct all amounts passing to a surviving spouse that qualify for a marital deduction.

Property that passes to the surviving spouse escapes taxation on the death of the first spouse, but is treated as part of the surviving spouse's estate for estate tax purposes. If the surviving spouse is in a higher tax bracket, property passing under a marital deduction is taxed at a higher rate when the surviving spouse dies. The marital deduction applies only if the surviving spouse is a U.S. citizen; otherwise a qualified domestic trust must be used to obtain its benefits.

The marital deduction applies to property that is left: 1) outright to a spouse; 2) in trust in which the spouse has the right to withdraw any or all of the property during his or her lifetime; or 3) in trust for the spouse's life under a Q-TIP ("qualified terminable interest property") trust.

A Q-TIP trust permits the surviving spouse to receive the income during the rest of his or her life, but the principal will be distributed according to the deceased spouse's wishes.

Plan ahead!

Do not let Uncle Sam take your hard-earned assets: Plan ahead!

Couples should maximize the $600,000 unified credit by creating lifetime trusts for -- rather than making outright distributions to -- the survivor. Married couples have the added advantage of the marital deduction; use it to eliminate any estate tax on the first death, even on those estates exceeding $1.2 million.

By prudently combining the unified credit, marital deduction and the annual gift tax exclusion, married couples can preserve their estates for their inheritors.


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**NOTE: The information contained at this site is for educational purposes only and is not intended for any particular person or circumstance. A competent tax professional should always be consulted before utilizing any of the information contained at this site.**