Q-1:

Subject: Advice on inheritance law

I am looking for a tax form number that has to do with estate and inheritance law.

 

I know I have a $2mm lifetime exemption, meaning that my heirs can inherit up to $2million dollars from me and not pay inheritance taxes on it when I die.

 

Let say I want to give my child $500,000 now and have it count as part of my $2,000,000.00 therefore reducing the amount that can be sheltered to $1,500,000 at the time of my death.  Also this shelters my child from paying gift taxes even though it's above the annual gift limit of $12,000.00.

 

What is the tax form number and where is my understanding wrong?

 

Thanks

A-1:

While it is good that you are trying to educate yourself on matters such as this, you are venturing into dangerous territory if you think you can set up an estate or gifting plan without the counsel of experienced professionals.

I have a very brief summary of the estate tax rates and exclusion amounts on my website.  As you can see, it changes every year, making it necessary to constantly revise estate and gifting plans.

You do have some basic misunderstandings of how these taxes work.  First is the fact that they are not levied on the recipient.  Gift taxes are payable by the giver and are tax free to the recipient.  Estate taxes are payable from the decedent's estate, with the remaining assets distributed tax free to the heirs, except for some kinds of assets, such as pre-tax retirement accounts.

There are many twists that can screw up an amateur gifting plan.  First is the fact that, while the lifetime gift tax exclusion used to be the same as the estate tax exclusion, that is no longer the case.  The lifetime gift tax exclusion is only one million dollars, half of the estate tax exclusion.

The process of gifting can be tricky, depending on what kinds of actual assets are being transferred.  While after-tax cash is easy to value, it's more tenuous with other kinds of assets.  There is also the issue of how the asset's current market value compares to its cost basis.

You can download the actual Gift Tax (709) and Estate (aka Death or Inheritance) Tax (706) forms and their instructions from the IRS.gov website.  Glance over them and you should realize that you are in over your head without the services of a qualified tax pro.

Good luck.

Kerry Kerstetter

Q-2:

Dear Kerry,

Thank you for your kind response.
First, I wholeheartedly agree with you that when I get ready to act, I will only do so with the aid of an experienced estate attorney. Not just an attorney, but one who deals heavily in estate planning.  Yet, at the same time, I also know that there is still the conflict of interest on the part of someone is both advising me on a course of action AND selling me a product to allow that course of action. 

For example, an attorney has a conflict of interest when advising a client on whether to go the route of a will or an AB Trust.  The trust is more costly for the client up front, but often the fees upon executing the trust at the time of death are much, much lower, possibly even nonexistent.  The cost of a will is minimal, but the cost to probate the will and settle the estate is often quite high.  The AARP says that probating a will and settling the estate often costs 5% of the estate value.

So even a most trusted advisor has a conflict of interest.  And as altruistic as a person can be, the conflict remains.  So it's my job to educate myself so I can intelligently listen and ask questions.

Here's the actual situation I am investigating.

My wife owns 10% of a family business that may soon be sold for $40,000,000.  Her portion will be about $4,000,000.  Since the company was worth $0 when she acquired her piece of the company, the entire $4mm is taxable at long term capital gains rate of 15% or $600,000.  That's a huge hunk of cash to just hand over without exploring other options.

Here's the option I'm investigating, and here's where my thinking and knowledge are suspect.
Let's say that on September 1, my wife dies and leaves me all of her estate.
1.  I would then receive her 10% ownership at current market value or step up in value.
2.  Say on September 30, I sold the 10% at current market value, which has not changed since September 1.  In my understanding, I would not owe any capital gains taxes since I inherited them at the same value that I sold them.

Of course, in this scenario, I owe inheritance taxes on the excess $2mm dollars above the life time exemption. At the rate of about 47% or so.

My question is this, could my wife take advantage of that $2mm lifetime exemption NOW?  Could she give me the $2mm of her company NOW and completely use up her lifetime exemption?  If so, I would now own 5% of the business, I would "inherit" it while she is alive, sell it and owe no long term captial gains since I receive step up in value.

It appears that this could work from an estate side, but now the gifting rules appear to be different.  So I don't think this could work.

If you have the time to comment on this situation or strategy I'd appreciate your input. If not, I understand and appreciate your earlier advice just the same.

A-2:

You have some good points; but are also still working under some misconceptions that would be cleared up if you were to work with an estate planning pro ASAP.

You are absolutely right that there are tons of conflicts of interest in the estate planning arena, especially with insurance salespeople who conveniently steer you into high commission policies and investments.

It is true that, for most people, probate costs are much higher than are actual estate taxes; especially when a living trust is not used.  Trusts do cost some money up front; but that is usually a tiny fraction of the savings down the road.

To address your issue with your wife, and if she were to die before you, you should know that on the 706, there is an unlimited (no maximum amount) deduction from the taxable estate for assets left to a surviving spouse.  This means that there is no estate tax actually payable after the first spouse's death if everything passes to you.

This means that the full estate tax burden falls on your estate, after you pass on.  For large estates, this creates another issue.  If your wife's 706 were to just pass everything to you, and then you die shortly after (in a few years), the total exclusion for the accumulated  estate would be just two million dollars, rather than the four million dollars two people should be able to claim.  What good estate planing attorneys do in situations like this is to make sure the first spouse to die utilizes her full exclusion by having two million dollars (or whatever the current amount is) worth of assets transfer into a spousal bypass trust at her death.  The trust will file income tax returns and generally pass its income through to the surviving spouse or whoever the designated beneficiaries are.  This means that two million dollars of wealth has been exempted from the estate tax.

Then, when you pass on, your estate will be able to claim its own two million dollar exemption.  If you have remarried in the meantime, you can set up a new spousal bypass trust, and so on.

You also seemed to miss my earlier point that the lifetime gift tax exclusion is only one million dollars, not two.

You and your wife really should start working with an estate planning pro right away to clear up these issues.

Good luck.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/23/2006 11:59:00 AM Send this post: