Despite strong congressional support for repeal of the federal estate tax, the tax is still with us. While the Economic Growth and Tax Relief Act of 2001 attempted to reduce or eliminate estate taxes, the result was a tax system with three phases: relief, repeal, and reappearance. Transfer tax rates are scheduled to decrease, and the amount that may be transferred free of estate tax (the credit equivalent) is scheduled to increase, until the estate tax is repealed in 2010. However, the rates return to 55%, and the credit equivalent to $1 million in 2011, unless Congress takes action.
In 2006, an estate worth more than $2 million is potentially taxable. If you're concerned about estate taxes, it may be worthwhile to investigate sophisticated techniques designed to lessen their blow, such as the QTIP (qualified terminable interest property) trust. QTIP trusts are a popular estate-planning tool for married couples with potentially taxable estates.
Although any amount you leave to your spouse is generally free of estate tax, you might not want to leave everything to your spouse. With a QTIP trust, you can set aside assets that earn income for your surviving spouse for the rest of his or her life. When your surviving spouse dies, the assets automatically pass to beneficiaries you have named, such as your children or grandchildren. As a result of this arrangement, your estate will not have to pay any estate taxes on the assets (although your spouse's estate may owe an estate tax).
For the Grandchildren
You might like the idea of giving a substantial portion of your wealth to your grandchildren. If that's the case, you should be prepared for the federal government's generation-skipping transfer (GST) tax, which in 2005 is a flat 47% tax on top of the estate tax. This tax could become due when your grandchildren actually receive the assets, which may not be for many years.
Fortunately, the first $2 million you give to your grandchildren is exempt from the GST tax. That may sound like plenty. But assets you set aside for your grandchildren may very well appreciate over the years. And if those assets are eventually worth more than the GST tax exemption amount, your grandchildren may be unpleasantly surprised with a hefty GST tax.
One way to avoid this tax on investment growth is to allocate your GST exemption to the assets going to your grandchildren up front. With this approach, future investment appreciation won't create undesired tax bills. The GST exemption will continue to apply to all of the assets, despite an increase in value.
A well-thought-out estate plan may be quite complicated and usually requires the assistance of a professional financial planner. But, when all is said and done, this complexity is a small price to pay for saving substantial taxes.
Scott Cangelosi is a registered representative of Lincoln Financial Advisors, a broker/dealer, and offers investment advisory service through Sagemark Consulting, a division of Lincoln Financial Advisors Corp., a registered investment advisor.
This information should not be construed as legal or tax advice. You may want to consult a tax advisor regarding this information as it relates to your personal circumstances.