How to Make $675,000 for Your Family

Did that get your attention?  Hope it did.  That’s how much you can save in estate taxes on a $3.5 million taxable estate by updating you obsolete will.  How long did it take for you to save $675,000.  That long?  Then read on.

If you and your spouse have an old-fashioned “All to my spouse” will and your combined estate is $5 million or more, then you are missing an opportunity for substantial estate tax savings, possibly in excess of $1,000,000.  And, if your combined estate is less than $5 million, the potential saving is perhaps not as great, but can represent a significant portion of your estate. So, how can you obtain this tax savings?

Example: You and your spouse have a combined estate of $3.5 million consisting of $1 million in the stock of your S Corporation business, a jointly-owned home worth $1,000,000, jointly-owned brokerage accounts of $1,000,000 and IRAs worth $500,000. The IRAs name the other surviving spouse as the beneficiary in the event of the account owner’s death.  Your 2 children are both adults.   In 1995, you each executed wills providing that all of your respective residuary estates is given to the other, if he or she survives you, and if neither is alive, then to your children.  In 2008, you die leaving  your entire probate estate (the assets controlled by your will) to your spouse.  Tax effect: No estate tax at your death, but assuming the combined estate is intact on your spouse’s death later in 2008, the estate tax bite would be $675,000 (45% of $1,500,000 ($3,500,000 gross estate-$2,000,000 unified credit for the property passing to your children)).

The Bypass Trust Alternative: Rather than paying $675,000 in estate tax, you can revise your estate plan and your will to take advantage of current tax law strategies.  The most important and easiest to implement is to change your will to utilize the $2 million estate tax exclusion (called the “credit shelter amount”).  The exclusion applies to property passing on death to someone other than your spouse.  What this means in practical terms is that if you set up a trust under your will that is funded with the first $2 million of assets in your name, that $2 million passes to those beneficiaries estate-tax free.  Now, that does not mean your spouse is left out of your estate, even if the credit shelter amount represents your entire estate. The credit shelter amount can be used to fund a trust under which your spouse is the beneficiary of the income for his or her lifetime. And the principal of the trust can be made available for his or her support.  Only on your spouse’s death need the benefits extend to your children and possibly beyond your children to your grandchildren.

The Property Ownership Problem: One catch to the scenario described above: The assets as currently described would not be enough to qualify to fully fund the Bypass Trust.  Why?  The will, as drawn, and even as amended to provide for the maximum credit shelter in a bypass trust, would not control jointly-owned assets.  They pass on death to the surviving owner.  In this case, they would pass to your surviving spouse and qualify for a marital deduction, thus eliminating all estate tax in the estate of the first to die.  Likewise, the IRA assets would pass to the beneficiary named in the plan, that is, your spouse.  So, these assets also would not be controlled by the will and would pass as marital deduction property. While not a problem in this example, the passing of so much of the estate of the first to die by means of joint ownership could endanger the intent of the estate plan contemplated in the will.

The big lesson: So, the co-equal and preceding step to revising the will is to re-title ownership of some of the assets to permit them to be controlled by the will.  One method commonly used is to change the title to jointly-held assets to assets owned as “tenants in common.”  In this way, each owner controls his or her share of the asset and his or her will would determine who receives it.  

Planning for the Imbalanced Estate:  Suppose that instead of jointly-owned assets, all or most of the assets are owned by one spouse.  If the imbalance of asset ownership is too great, what might be needed is to shift total ownership of selected assets into the name of the spouse with the underweighted proportion of the estate.  This could be done until both estates are as equal as practicable.  In that way, as much as possible of the full credit shelter will be utilized in both estates.

As the foregoing discussion demonstrates, this strategy will require the detailed analysis of assets and goals that is part of a full estate planning process.  The preferences of clients are the predominant consideration, both as to the selection of the right strategy and the details of its execution.      

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