Typically people come to our office looking for a Will, which gives all of their assets to their spouse, if living, and if not, their children. Many times our clients know that there is an estate tax, but most have no idea that the estate tax could affect them.
I generally ask our clients to complete a brief asset worksheet which usually reveals something like this:
Equity in the Primary Residence = $200,000
Qualified Retirement Plan (i.e. IRA) = $200,000
Stocks and Bonds = $100,000
Term Life Insurance (Face Value) = $2,000,000
TOTAL = $2,500,000
Most people ask, "Why do you want to know the amount of our life insurance, its not subject to tax anyway?"
They are in part correct. Life insurance is not subject to income tax. But it is subject to the estate tax.
As stated in previous articles, the life-time exclusion amount for each person in 2011 will be $1,000,000 unless Congress acts. This means that if you die in 2011 the amount that exceeds $1,000,000 will be subject to an estate tax with a top rate of 55%.
Let play this out with the above clients. Assume that the above clients are a married couple and they would like an "I love you Will," which gives everything to one another first then their children.
Under current federal and Washington state estate tax laws, a husband and wife may transfer an unlimited amount of property to one another free of estate taxes (called the unlimited marital deduction). Assume that husband dies in January 2011 and gives everything to his wife. Now, the wife's estate is worth $2,500,000. If she dies the following December leaving everything to the kids, then $1,500,000 will be subject to the estate tax at a top rate of 55%. So wife's children could be looking at roughly a $800k tax bill.
However, if the couple had their estate planning attorney draft a "credit shelter trust" in their Will, rather than going with the standard "I love you," they could have saved their children the $800k.
So what's a credit sheleter trust? It is a paragraph in your will that says if I die before my spouse then I want a portion of my estate to go into a trust for the benefit of my spouse's health, education, support and maintence. The suriving spouse can be the trustee of this trust as well as the life-time beneficiary. When she dies, the rest will pass to the children in equal shares.
If husband dies with a credit shelter trust, then an amount equal to the life-time exemption amount ($1 million in 2011) of the husband's total estate goes into the credit shelter trust for the benefit of the surviving spouse. The rest of the husband's estate ($250,000) passes to the surviving spouse outright. No estate tax is paid at husband's death because he used his $1 million exemption amount to shelter the property that went into trust, and the $250,000 that transferred to wife passed tax free under the unlimited marital deduction.
Wife now has a $1,500,000 million dollar estate rather than a $2.5 million dollar estate. Now she can use her $1 million exclusion amount to shelter all but $500,000, saving over $500,000 in estate taxes.
The credit shelter trust is a widely used estate planning tool used by many people in this situtation. However, there are many other tools that can be used to save even more. In the articles to follow, I will address what the wife can do to shelter the remaining $500,000 from the estate tax.