ESTATE
Do Your Heirs a Favor: Plan Your Estate for Taxes
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GLOSSARY
Unified Credit Trust
These trusts go by a variety of names, including unified credit trust and QTIP trust. They're used by married couples so that a surviving spouse can take maximum advantage of his or her exemption from estate taxes. Without these trusts, the entire estate of the first spouse to die usually goes to the surviving spouse estate tax free. But unless the surviving spouse can lower his or her estate down below the limit, estate taxes will be assessed upon the death of that person.
ongress finally got the message and changed the nation's estate tax laws so that, once again, only the rich are affected. Right? That's what legislators and the media have said since the 1997 Taxpayer Relief Act was passed, raising the exemption on estate taxes.
But that's only partly true. So if you're counting on the estate tax changes to save you, it could cost your heirs dearly upon your death.
An unprecedented eight-year stock market run has increased the value of real estate, retirement funds and other assets to the point where many people who would have died without forcing their heirs to pay estate taxes face a far different reality today. In the interim, the amount of people's estates exempt from taxes has not increased.
The last time estate tax laws were changed was in 1987. Congress should have raised the $600,000 exemption on estate taxes by 3 percent in each of the succeeding years just to keep pace with inflation. It didn't, waiting until 1997 to begin an eight-year phase-in of higher exemptions.
We should expect this lack of response from Congress. But the second piece of bad news is what really scares financial advisers and estate planners: The news media is only giving the public small bites of information. Many of us think we're all set in the estate tax department when really our estate planning is in deep trouble.
This is why you need to look at the facts to rid yourself of any misconceptions you may have about the new laws. Armed with accurate information, you can maximize many ways to reduce or eliminate your estate taxes.
Gradual exemption increases
Starting in 1998, the exemption (sometimes called the "unified credit") gradually increases, beginning with $625,000 and rising to $1 million in 2006. But the phase-in is done in bits and pieces for the first several years, increasing in $25,000 increments for each of the first four years.
The unlimited marital deduction is still in place, which means that you can leave everything to your spouse and whatever is left over is included in your spouse's estate upon his or her death. The problem is that the magic words "$1 million" were trumpeted in the press and many people now mistakenly believe the $1 million unified credit started in 1998 and they're home free - no estate tax planning is needed.
The fact is, if you have a home that's increased significantly in value over the past several years, as well as a retirement plan or other assets, you could end up costing your heirs tens of thousands of dollars in unnecessary taxes. I call them "unnecessary" because if you plan your estate correctly, the heirs won't pay Uncle Sam for the privilege of getting what's already legally theirs.
Small-business and farm owners affected
The misconceptions about estate taxes also have spilled over to small businesses and farm owners. The 1997 tax laws raised the exemptions in those areas to $1.3 million.
So you think your small business or your parents' farm in the Midwest automatically qualifies the estate for this whopping exemption? Think again.
The new complicated rules require the farm or business to account for at least 50 percent of your estate. In addition, it has to go to "qualified" heirs. And they must keep the business or farm going for another decade after your death or additional taxes kick in to "recapture" part of the tax benefits your estate got when you died.
Financial troubles can result, inexperienced beneficiaries can quarrel and marriages can break up. So when doing your estate planning, you need to make sure you have a plan in place to keep that business or farm going for 10 years before you assume the $1.3 million will apply.
Complacency will cost you
The lesson here is to not be lulled into complacency. If you even suspect that your taxable estate is hovering in the $500,000 range, it's time to do some serious estate planning.
Why $500,000 rather than $625,000, the amount exempt from estate taxes in 1998? Because what you think your assets are worth and what the Internal Revenue Service thinks they're worth may be two very different things. You may be undervaluing your house or other assets. And remember that any insurance you own is included in your estate at its death benefit value.
Find your will (and if you're one of the more than 50 percent of American adults who don't have one, get one). See if it includes a unified credit trust or other device to minimize estate taxes.
At the very least, you need a will that takes into consideration the changes in value of the estate tax exemption every year for the next 10 years. However, be aware that some lawyers are frowning on codicils that mention specific dollar amount increases each year because of concerns the numbers could change again or because it ties the will to dollar figures.
Some tips on minimizing your estate taxes
It's important to note that changes in the amount of the unified credit should not result in any fundamental changes in estate-planning techniques. Most estate plans that include tax planning will automatically adjust to the larger exemption. Your estate planning should include setting up wills and living trusts but note that most wills and living trusts do not initially include any tax-planning provisions.
If your taxable estate is high enough to be vulnerable to the IRS, here are some things you can do to minimize estate taxes upon your death:
1.
If you're married and have a unified credit trust, make sure you have your assets in the correct names or you'll have paid legal fees for nothing. If you have everything in joint tenancy with right of survivorship and your spouse's name as the beneficiary on all of your retirement plans, you have just lost your chance to save big bucks. There won't be any assets going into the trust that stay out of your spouse's estate, so everything would get taxed at the second death.
2.
Annual gifting: In 1998, you can give up to $10,000 to anyone you'd like without paying taxes on it and it doesn't count toward using up your unified credit amount. This is a great technique to slowly pass on your holdings to heirs or if you have a rapidly- appreciating asset since all the appreciation occurs outside of your estate in the hands of your recipient. After 1998, the $10,000 is indexed with inflation. Caution: If you name yourself as custodian for a minor on the account, it's included in your estate, a real concern if you are a grandparent giving money to a grandchild.
3.
For the wealthy, those of you who have already ensured the finances of your children, you can create a generation-skipping trust. This trust bypasses your children and goes directly to your grandchildren. In 1998, the tax-free amount you can use is $1 million (in the years to follow that amount will increase with inflation).
4.
For the charitably minded: Set up a durable trust. You put assets in it, naming your favorite charity as the ultimate beneficiary. You can take the tax deduction now while continuing to receive income from it for as long as you're alive. At your death, the charity gets the assets.
Before you give away any of your assets, make sure that a competent financial advisor prepares cash flow scenarios for you showing how your finances will be affected without that money. The assumptions should be very conservative: Assume that you will live five years past the year in which you are actuarially expected to die, and assume that you'll have significant medical problems requiring nursing or home care for the last few years. With increases in health-care costs as well as in longevity, you need to protect yourself.
And never give away assets based on the promise of the recipient (usually one of your children) to "take care of you no matter what." Too many trusting parents have died with empty wallets and broken hearts because their well-meaning children did not come through for them as promised.
Finally, remember that the worst estate planning is no planning at all. We taxpayers have been given a gift, albeit well deserved. Now use it. 
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Illustration by Terry Allen Copyright 1998 Microsoft Corporation