As 2003 is coming to an end, many people begin to reflect on the year past and begin to plan for the upcoming new year. While estate and tax planning is not often the foremost concern, it is important to remember that a well devised estate plan balances tax considerations against your every day needs and your future desires. In light of the nearing year end, the changing Internal Revenue Code, and new rules regarding estate tax, it is a prime time for everyone to reconsider their existing estate plans or consider implementing an estate plan for the first time.
An integral element of all estate planning is the application of the unified credit and the applicable exclusion amount. Many people have heard these terms or understand generally that they provide for a one million dollar exclusion of assets from estate tax in 2003. However, the unified credit is, in fact, a far more encompassing credit that does not only impact estate tax. Appropriately titled, the unified credit joins two distinct taxing regimes under the United States Internal Revenue Code. As of January 1, 2004, the unified credit facilitates the transfer of up to $1,500,000 of value from any person without the imposition of either federal estate tax or federal gift tax. This is a $500,000 increase from the $1,000,000 limit in 2003. What is not commonly understood is that all “taxable transfers,” whether made during life as a gift or at death by operation of a testamentary devise, reduce this credit limit.
What is a “taxable transfer”? A taxable transfer is any transfer of money, property, or services that is in excess of the Section 2503(b) annual exclusion amount (currently $11,000 per person per year and available only for lifetime transfers) and any transfer that is not a “qualified transfer” for educational or medical expenses. Thus in 2004, if a parent writes a check for $211,000 to a child to purchase a new home, $200,000 is a “taxable transfer”. The parent would be required to file a gift tax return for the “taxable transfer;” however, the parent would not be required to pay gift tax on the amount because the exclusion amount shields the transaction from gift tax. However, if that parent died in 2004, the parent’s estate would be free of estate tax only to the extent of $1,300,000 (the remaining exclusion amount after the lifetime gift to the child). If on the other hand, the parent did not give the child $211,000 during life and made no other taxable gifts, then at his death in 2004, $1,500,000 of the parent’s estate would be excluded from the estate tax. As you can see, the gift tax structure and the estate tax structure are joined for purposes of applying the exclusion against tax.
The increase in the exclusion amount also impacts estate planning for spouses. Often spouses create an estate plan combining a marital trust share and a credit-shelter trust share determined by a formula funding the credit-shelter trust share with the maximum exclusion amount available at the spouse’s death. When the exclusion amount increases to $1,500,000, this will shift a greater amount of the deceased spouse’s estate to the credit-shelter trust share and away from the marital deduction trust share. As the amount of the exclusion increases through 2010, more and more money will be shifted from the marital trust share and transferred into the credit-shelter trust share. This means that if the credit-shelter trust passes to anyone other than the spouse, the spouse may ultimately be disinherited. Accordingly, it may be important to re-evaluate the impact of the increased exclusion amount on your estate plan and your spouse’s estate plan.
Beginning in 2004, the Internal Revenue Code is linking the amount of the generation-skipping transfer tax exemption amount to the exclusion amount. Generally, generation-skipping transfer tax is an additional tax imposed on the transfer of assets (either at life or after death) from a member of one generation to a member of a generation that is two below their own (typically a grandparent to a grandchild). In 2003 and prior years, the Internal Revenue Code provided every individual a generation-skipping transfer tax exemption in the amount of $1,000,000 (indexed for inflation) – meaning an individual could transfer up to $1,000,000 to grandchildren without imposition of generation-skipping tax on the transfer. Beginning in 2004, a grandparent may transfer up to $1,500,000 to grandchildren without the imposition of an additional generation-skipping transfer tax. This exemption amount will continue to mirror the applicable exclusion amount as it increases through 2010.
Similar to how an increased exemption amount may shift assets from the marital deduction share to the credit-shelter trust share, an estate plan that currently maximizes the generation-skipping transfer tax exemption may shift an increased share of assets away from children or spouses and allocate such assets to grandchildren. This shift in asset distribution will continue to increase through 2010, as the exemption amount increases, and may ultimately serve to disinherit children or greatly skew the intended outcome of an estate plan.
The applicable exclusion amount is often the starting point for determining what unique tax planning your estate requires and what benefits can be derived from lifetime giving in addition to testamentary giving. Estate planning, however, is much more than simply determining the amount of tax your estate may or may not be required to pay. As this new year approaches take the time to consider and discuss with your loved ones how your lives have changed since you created your existing estate plan and whether you would like to restructure different elements within it. As with any tax or estate planning, we encourage our clients to learn about the available options and consider different possibilities. Please let us know if we can assist you.