Death and Taxes
In planning an estate, lawyers use three types of mechanisms to avoid or delay payment of Federal estate taxes. Planners attempt to maximize the use of a $1.5 million unified Estate and Gift Tax credit. Basically, this credit allows you to deduct $1.5 million from each of your estates, less any deductions made prior to your deaths for gift taxes. Plan carefully, however because this credit is a moving target! It is increasing each year and will become unlimited in 2010.
But what the Federal Government gives, the NJ State Government takes away. New Jersey now taxes estates greater than $675,000.00 (not including the value of assets transferred to a spouse). This is called the New Jersey Estate Tax.
There is a second type of death tax imposed by New Jersey as well: the Transfer Inheritance Tax. The Transfer Inheritance Tax does not apply to bequests to a charity or to the spouse, children or grandchildren of the deceased, but does apply to any gift over $25,000 to a brother or sister and to all gifts to more distant relatives and strangers.
Making gifts during one's lifetime is the second mechanism used to reduce estate taxes. These gifts, however, may be subject to Federal Gift Taxes, which reduce the $1.5 million unified credit unless they are carefully structured. Gift Taxes may be payable if you made a gift of any money or property. For example, if you made a down payment on a house on behalf of one of your children, that gift may incur a Gift Tax. If a gift is worth less than the annual exclusion each individual receives and if that gift otherwise qualifies for this exclusion, however, gift tax is not imposed.
Until 1973, the annual exclusion was $3,000. The current annual exclusion is $11,000 for all the gifts each parent makes to each child in any one year. If you and your spouse make a joint annual gift to each of your children of $22,000, that gift does not incur a Gift Tax and does not reduce your $1.5 million unified credit.
Gifts can be extremely complicated. They can take the form of trusts funded by life insurance proceeds, or interests in real property. They can also take the form of accounts under the Uniform Gifts To Minors Act. Once such a trust is established, it takes on a life of its own and may be required to file its own tax return and send correspondence to its beneficiaries on a regular basis.
The third mechanism used by estate planners to minimize Federal taxes is an unlimited exclusion from estate taxes for assets of a certain type, transferred to one's spouse. If you hold assets worth more than $2 million, (or if you are younger and hold assets worth more than $10 million) the issues involved are, as you might imagine, complicated. It is often necessary for an estate planner to receive a large amount of information from you and copies of many documents, such as documents establishing the trusts held for your children. A planner also needs information concerning the way in which those trusts were funded to determine whether, in funding those trusts, the then applicable annual gift tax exclusion was available. You should be prepared to complete a rather lengthy Information Statement and Asset Inventory before any planning actually takes place.
Estate Planning: it Ain 't Just Wills
Estate Planning does not end as soon as the ink is dry on your Will. Other documents, such as trusts, life insurance policies, deeds and bank account signature cards have an effect on your estate plan. That effect can be either intended or unintended. In New Jersey, a Will cannot be informally changed, but it can refer to another document which can be updated occasionally.
One type of document frequently referred to in a Will is a trust. A trust may be created in a Will or outside a Will. A trust created within your Will does not take effect until your death. A trust created outside a Will usually takes effect immediately, but may not be funded immediately. For example, a trust for a child may be created today but not funded until the death of the parent. At death, a provision in a "Pour over Will" transfers assets to the trust. Trusts created outside a Will are usually irrevocable, which means they cannot be cancelled by the person who established them.
Another type of trust is revocable by the person who created it: the so called "Living Trust". A living trust is usually touted as a way to avoid probate. The pitch is that Probate is BAD and living trusts are GOOD. Probate in New Jersey takes ten days and generally costs less than $200. While a Will must be filed publicly, a trust must also be filed publicly when anyone challenges the actions of the trustee.
One final word of caution is in order: Look closely at the fees charged for creating such living trusts and transferring assets to them.
Another kind of informal adjustment to your Estate Plan is adjusting the amounts of life insurance you own, as well as transferring ownership of the policies you now own and changing the beneficiary of these policies.
A third kind of informal estate planning is transferring ownership of real estate or bank accounts into joint names and adding Payable on Death provisions to other bank accounts. Some Pension Plans provide death benefits and the beneficiaries of those benefits may be changed, but spousal consent is sometimes required. Under current law, however, no spousal consent is required to change the beneficiary on an IRA account.
Here are some pitfalls to note:
• When a trust is created, income and gift tax returns may be required, trustee’s commissions may be incurred and occasional correspondence to beneficiaries may be mandated, which can be costly.
• If the trust is irrevocable and your assets are not limitless, you may spend the assets not placed in the trust during your lifetime and have insufficient assets to live, since you are unable to use the funds in the trust. Some people have complex estate plans, which render them penniless. A Court procedure is then required to remedy the situation.
• If you transfer ownership in life insurance, the transfer may not accomplish its aim unless you live for three years.
• If you transfer a bank account into joint names, you also give the joint owner the right to immediately withdraw all the money in the account. Therefore, this could either be an inexpensive estate planning strategy or an unwitting financing of a spending spree.
• Further, if you transfer real estate to a child by adding that child's name to a deed as a joint owner, you might not be doing that child a favor. If your Will left the real estate to your child, the "basis" of the real estate would be the market value at your death. If your child sold the property, your child would pay capital gains tax on the difference between the "basis" and the sales price. In contrast, if you name you child a joint owner, the basis is the price you paid for the property. If you are transferring a home you bought 30 years ago for $25,000, which is now worth $350,000, this difference is substantial.
As these examples illustrate, each strategy has its pros and cons. It takes an experienced practitioner to walk you through this gauntlet and help you establish a workable
estate plan.
Opportunities for the Chairman of the Board
If you own a corporation, you are able to take advantage of special estate planning opportunities. On the other hand, you probably have a second set of problems in planning for the transfer of control of your business. Because the Estate Tax laws recognize you have the second set of problems, they help you with the first set of problems concerning Estate Planning.
Since the federal government recognizes that it is important to keep your business running (and your employees working) after you pass away, the tax laws allow the Estate of an owner of a small corporation, whose major asset is stock in that corporation, to spread tax payments over time and to use special rules that reduce the estate tax on real estate used by a small business.
An owner of a small corporation is also in a unique position since he or she can tailor the corporation's benefit plans to work in harmony with an estate plan. The corporation can establish or modify a 401(k) plan, a profit sharing plan and insurance coverage to maximize benefits. The structure of the corporation itself and the types and amounts of corporate stock issued can also be used to great advantage. Stock Purchase arrangements are also powerful estate planning tools. Your stock may be purchased by another shareholder or by the corporation itself. The purchase price may be paid to your spouse, your Estate, your children or the corporation. Some of these arrangements have favorable income tax consequences, as well. It is worthwhile for the owner of a small business to sit down with an experienced estate planning practitioner to discuss alternatives.
PARTING WORDS
A comprehensive estate plan includes more than just a Will and takes into consideration your real estate, bank accounts, insurance policies retirement arrangements and any stock you own in a small corporation. You should consider Powers of Attorney and Living Wills, which are important parts of any estate plan. In a broader sense, you may also want to plan financially for your last illness. This would require you to consider your present assets and how they are held in the light of Medicare regulations. Arrangements should also be made to advise your family, your health care providers, and your other advisers of your wishes.
For additional information regarding these subjects, feel free to contact Michael Bolton, Esq. at (973) 425-0497.
