2008 Year End Estate and Trust Taxes and Planning: Before It’s Too Late!

Although year-end tax planning generally focuses on income taxes, a thorough year-end tax assessment should include reviewing your estate plan and estate tax situation as well. In 2008, the highest marginal estate tax rate is 45 percent. If your estate is large enough to be subject to this tax, you can begin planning to reduce or eliminate that tax liability. Without proper planning, the estate tax can consume a substantial portion of your estate, leaving less property for your loved ones.

1. How Do I Know If My Estate Is Subject to Estate Tax?
The estate tax generally is based on the fair market value of a person’s estate at death. However, every estate is entitled to an exclusion that effectively exempts a certain amount of property from the tax. This exclusion amount currently is scheduled to increase over time and is illustrated in the chart below:

Based on the estate tax exclusion, in 2008 an individual can pass $2 million to the next generation estate tax-free. A husband and wife can pass up to $4 million estate tax-free if their estate is properly structured and their assets are properly titled.
Although everyone has an estate tax exclusion, it could be wasted if an estate plan is not properly structured or assets are not titled properly. The key is to make sure that an individual has assets at least worth the exclusion amount in his or her name or in a trust that is included in his or her estate for estate tax purposes. If a husband and wife own all of their assets jointly (or one spouse owns the majority of the assets and the other spouse owns little or no assets), they run a good chance of wasting one of their exclusions, thereby subjecting more property than necessary to estate tax.
To ensure full utilization of both spouses’ exclusions, each spouse should have at least $2 million in their name or a trust that is included in their estate for estate tax purposes.
For married couples, the estate tax law also provides an unlimited marital deduction. This deduction allows an individual to leave an unlimited amount of assets to a surviving spouse (either outright or in certain types of trusts) without incurring an estate tax on the death of the first spouse. Proper marital deduction planning allows an individual to defer estate tax until the death of the surviving spouse.
In order to determine if your estate is subject to estate tax, review the assets you own and determine what they are worth. What you own is broader than just your security portfolio. Your estate generally includes real property, the death benefit of life insurance (unless you do not have any “incidents of ownership” with respect to the policy), IRAs and other retirement plan benefits. Add the value of these assets up. If they total less than $2 million, your estate should not generally be subject to estate tax, assuming you did not make any taxable gifts during your life. If your estate is worth more than the estate tax exclusion, you may want to consider meeting with your professional tax advisor to determine what opportunities are available to reduce this tax in a way that is consistent with your overall estate planning goals and objectives.

2. What’s All This I Heard About Estate Tax Repeal?
In 2001, tax legislation was enacted that repealed the estate tax. However, this repeal is being phased in over time. In 2008, we still have an estate tax. The exclusion chart shows how the phase-out of estate tax repeal is scheduled to occur. It is based on an increasing amount an individual can leave without incurring an estate tax (i.e., the estate tax exclusion). As of now, the estate tax is set for complete repeal only in 2010 only because a sunset provision in the tax legislation repealed the estate tax for just one year. The estate tax is scheduled to be fully reinstated in 2011 (with an exclusion amount of only $1 million), unless Congress acts to make the repeal permanent. To date, Congress has not been successful in passing legislation that would make estate tax repeal permanent. There are numerous proposals floating around Washington that seek to minimize the burden of the estate tax short of complete repeal. One proposal that has gained attention would increase the estate tax exclusion amount to $5 million per individual (as opposed to $2 million per individual) and tie the estate tax rate to the capital gain rate for smaller estates or two times the capital gain rate for larger estates. It is important to remember that no one knows if the estate tax will be repealed or whether a compromise proposal will even be reached. Therefore, proper planning is still essential.

3. What About Family Limited Partnerships?
Many people have created family limited partnerships for estate, asset protection or other purposes. From an estate tax perspective, assets are put into an FLP and, in return, limited partnership interests are received. These limited partnership interests have traditionally generated discounts for gift and estate tax purposes because they are not marketable and provide no control over the management and operation of the FLP. Because of the discounts, the limited partnership interests are worth “less” than the limited partnership interests’ proportionate value of the underlying assets in the FLP. Since the limited partnership interests are not as valuable as the FLP’s assets, less estate or gift tax would ultimately be due.
The IRS has been challenging the estate tax benefits that have traditionally been available to FLPs. These challenges have culminated in a series of successful court cases for the IRS. The IRS has had success in cases where the facts indicate, among other things, that the person who established the FLP either controlled the partnership or had an express or implied agreement that he or she would benefit from the FLP property if needed. These cases tended to involve transactions in which substantially all of a person’s assets were transferred to an FLP and there was no real or business purpose to engage in the planning other than to generate estate tax discounts.

If you have engaged in estate planning that includes an FLP, it would be prudent to review the impact of this recent string of cases on your plan. This review should include not only determining if there are any problems posed by the creation or operation of your partnership, but also what, if any, remedies can be pursued if a problem exists.

4. What Should I Be Thinking About Before Dec. 31, 2008?
a. Annual Exclusion Gifting
If an individual is subject to the estate tax, one manner to reduce that future liability is by making gifts. If gifts are made while you are alive, the gifted property, plus any appreciation generated by that gifted property, would be removed from your estate for estate tax purposes.
The tax law provides every individual with an annual gift tax exclusion. Under this exclusion, the first $12,000 of gifts ($24,000 for married couples who elect to split gifts) made by a donor to each donee in calendar year 2008 is excluded from the amount of the donor’s taxable gifts. Utilizing these exclusions can save both transfer tax for the donor and family income taxes because the annual exclusion makes the transfer free of gift tax. Estate tax can be saved because both the value of the gift and post-transfer appreciation will not be included in the donor’s estate. Subject to the kiddie tax rules, family income tax savings can be realized when income-producing property is given to family members in lower-income tax brackets.

To take advantage of annual exclusion gifting for 2008, you must act no later than Dec. 31, 2008, by making a completed gift. Unused annual exclusions cannot be carried over to future years.
Planning Point: A gift must be “complete” in order to get an annual exclusion credit. Typically, a gift is complete when the donor gives the property to the donee. However, care must be taken when gifts are made by check. If a gift of a check is made near the end of 2008 and the donor wants to take advantage of the exclusion for that year, the donee must deposit the check before year-end so there is no doubt when the gift was made. Direct deposit of funds into the donee’s account would be even better.
b. 529 Plan Gifting
Contributions made to a 529 Plan are treated as gifts and will therefore use some or all of an individual’s annual exclusion. However, because of a special provision in the tax law, an individual is allowed to make a lump sum contribution of up to $60,000 to a 529 Plan for any number of donees and treat the contribution as if it was made ratably over a five-year period. If a person makes this election, he or she will not exceed the $12,000 per year gift tax exclusion. In effect, he or she will be using future annual exclusions so the amount that can be gifted in future years by annual exclusion gifting will be reduced. The benefit of making a lump sum contribution is that there is more money in the 529 Plan available for growth.

5. What Should I Be Thinking About Before April 15, 2009?
a. Make Annual Exclusion Gifts Early in the Year
For those individuals who are making annual exclusion gifts, there is no reason to wait until the end of the year to make the gifts. Beginning Jan. 1, 2009, a person can begin making annual exclusion gifts for 2009. The benefit of making the gifts early in the year is that any appreciation on the gifted property during the year would not use up any of your annual exclusion.

b. Funding Your Revocable Living Trust
Many clients have revocable trusts as part of their estate plan. One of the main reasons people establish revocable trusts is to avoid the cost and delay of probate. However, simply signing a revocable trust is not enough. A person’s assets need to be re-titled in the name of the trust to avoid probate. If you have a revocable trust as part of your estate plan, it is a good idea when you are gathering all of your income tax information to review your brokerage statements, 1099s and other tax statements to see how your assets are titled. It could be that you have an estate plan that looks good on paper but will not achieve the probate avoidance results you anticipated because your assets are not titled appropriately.

c. Complex Trusts and Estates Can Choose the Tax Year for Deducting Distributions
Complex trusts and estate distributions made within the first 65 days of 2009 may elect to be treated as paid and deductible in 2008. As a result, fiduciaries do not need to make payments in 2008 for those payments to be deductible in that year. They can wait until 2009, when the 2009 tax picture should be clearer, to decide whether the payments should be imputed back to 2008 or treated as 2009 payments. If an estate or complex trust elects to treat a 2008 distribution as paid in 2008, the distribution is taxable to the beneficiary in 2008.
Of course, there are many more strategies that a person might want to consider implementing as part of his or her estate plan. As always, the key is proper planning. The end of the year is a good time to review your estate plan to determine if it still meets your goals and objectives and maximizes all estate tax planning opportunities available. If you have never executed an estate plan, the end of the year also is a good time to begin the process.