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Federal Estate Tax Law to Change


The larger and more complicated the estate, the greater the challenge in developing an encompassing plan to maximize the transfer of wealth to heirs. So, over the next few months, keep an eye on what Congress is doing with regard to federal estate tax law.

In 2001, President George W. Bush and Congress collaborated to enact a plan to gradually lower the estate tax rate to 45% and gradually raise the amount that can be left to heirs free of federal taxes to $3.5 million for individuals in 2009.

Under the plan, the estate tax was scheduled to disappear completely in 2010, and then, in 2011, revert back to the 55% tax rate and $1 million exemption level of 2001. It appears, however, that neither of those things will happen, although there are differences of opinion in how the estate tax will look in the future. President Obama has stated he would like to see exemption levels and tax rates remain the same in 2010 as they are this year. At the same time, Congress is currently mulling a wide array of proposals that would modify federal estate tax law. Some would keep the current $3.5 million exemption for 2010, some would decrease it to $2 million, and others would increase it to $4 or $5 million.

Beyond 2010, some bills would index the exemption for inflation, while some would not. In addition, the collection of bills have the maximum federal estate tax rate varying anywhere between 35% and 55%. Clearly, there is no consensus right now in Congress regarding the future of the estate tax, and they don’t have much longer to take action.

As January 2010 approaches, the likelihood that Congress will extend 2009 federal estate tax law increases. But, regardless of the eventual outcome, affluent investors should be sure to take the necessary steps to ensure that the prime beneficiary of their life's hard work isn't the government. The first thing to consider is that the state in which you live may have different exemption limits than the federal government. This is the case if you are a resident of New Jersey or New York, which have individual exemptions of $675,000 and $1 million, respectively. The next thing to do is to take some basic steps to ensure your final wishes are honored and your money transfers efficiently to your intended heirs. This includes having a will, a durable power of attorney, an Advanced Medical Directive (living will) and a Medical Power of Attorney.

Powers of attorney allow others to make decisions (medical and financial) for you in the event of an inability on your part to do so. An Advanced Medical Directive spells out your wishes with respect to medical treatment, such as requesting that no extraordinary measures be taken for life support.

Wills cover the great majority of assets that pass through the estate, and may include disclaimer provisions and credit shelter trusts to protect assets from estate taxes and to take advantage of the full exemption amount. Homes, taxable accounts, savings and checking accounts are the types of assets that transfer according to a will. On the other hand, IRAs, qualified retirement accounts, and insurance proceeds all have the ability to have a beneficiary attached to them. The stated beneficiary allows the asset to pass outside of the probate process and go directly to the beneficiary. But just because it does not go through the probate process, does not mean that it avoids tax consequences.

The probate process differs by state. In New Jersey, it is simple, inexpensive and not at all time consuming. In New York, that is not the case. So, in order to avoid the probate process, some New York residents use revocable living trusts. These trusts allow assets to avoid passing through probate and can streamline the management of those assets, although they do not protect the assets from estate taxes.

More sophisticated estate planning techniques include:

  • Irrevocable Life Insurance Trust (ILIT) to remove life insurance policies (and therefore proceeds) from an estate.
  • Qualified Terminal Interest Property (QTIP), frequently used with second marriages to provide income to the surviving spouse yet ensure assets go to children from a previous marriage.
  • Qualified Personal Residence Trust (QPRT) to remove a house from an estate.
  • Family Limited Partnerships to remove manageable assets/business interests from estates (among other things).

Certainly, the larger and more complicated the estate, the greater the challenge in developing an encompassing plan to maximize the transfer of wealth to heirs. So, over the next few months, keep an eye on what Congress is doing with regard to federal estate tax law, and in the meantime, start thinking about how the law may impact you and your family in 2010 and beyond.

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Victor J. Dzau, MD, gives expert advice
Victor J. Dzau, MD, gives expert advice