Effective estate planning is essential if you want to preserve your wealth for your children. Beware of making these common estate planning mistakes if you want to avoid paying unnecessary extra estate taxes (death taxes) to the IRS and state taxing authorities thus reducing your children's inheritance. You will be pleased to know that these costly mistakes are easily avoided with proper planning.
Failure to recognize the significance of the State estate tax law.
Many states have their own estate tax (death tax) and the overwhelming majority of those have "decoupled" their estate tax from the Federal estate tax, which means that your estate could be subject to state estate tax even if no Federal estate tax is due.
Since the Federal estate tax exemption currently is $5.12 million (for 2012 only) and the state thresholds for states that impose their own estate tax all are under this amount (most commonly, at $1 million), without proper planning, this discrepancy could result in an unpleasant surprise for your heirs upon your death. You need to review your current financial situation to determine the potential exposure to state estate tax and learn how to minimize it.
Misunderstanding the new Federal estate tax law that went into effect in 2011.
Many sighed in relief when President Obama signed the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 on December 17, 2010. They believed that death taxes for all but the very well-to-do were effectively eliminated.
The Act provides for an death tax exemption of $5 million for 2011 and $5.12 million for 2012. The Act also provides for "portability" between spouses of the death tax exemption for estates of decedents dying in 2011 and 2012. Unfortunately, this new regime is temporary and will sunset on December 31, 2012. The death tax regime that existed prior to 2001, with a 55% maximum death tax rate and a $1 million exemption, will be reinstated then.
Although Federal tax law has been temporarily revised, many states continue to have an estate tax exemption of only $1,000,000, with no "portability" of unused estate tax exemption between spouses. You can't afford to ignore tax planning if you want to minimize or avoid state estate taxes.
With the current Federal estate tax law set to expire at the end of 2012, and the exemption amount scheduled to revert to $1 million as of January 1, 2013, all planning today should reflect the possibility that things may revert to pre-2001 law.
Leaving everything to your spouse.
Many couples own the bulk of their property jointly and have reciprocal Wills in which the wife leaves everything to the husband and the husband leaves everything to the wife. This is generally an inefficient tax arrangement for couples whose combined estates may exceed the typical $1million state death tax exemption because it wastes the available exemption of the first spouse to die, leaving only the $1 million exemption of the survivor to avoid death tax. Although because of the unlimited marital deduction there will be no death tax due if you leave everything to the surviving spouse when the first spouse dies, the surviving spouse's estate will be subject to death tax if the property owned by the surviving spouse (including the property inherited from the first spouse) exceeds the $1 million exemption.
The loss of an estate tax exemption may be avoided if provisions in the will or living trust agreements create a "credit shelter" or "bypass" trust at the death of the first spouse. In a typical credit shelter trust, the surviving spouse is entitled to receive all of the income from the trust for their lifetime, and has the right to withdraw principal for health, education, support and maintenance in line with their accustomed manner of living. When the surviving spouse dies, the $1 million in the credit shelter trust (including any appreciation as well) goes to the children free of death tax.
The amount which funds a typical credit shelter trust varies according to your financial and family circumstances. For death tax purposes, the credit shelter trust should be funded with up to the state exemption amount (typically, $1 million). The credit shelter trust may be funded with an additional amount up to the Federal death tax exemption ($5.12 million for the year 2012), depending on the client's Federal death tax exposure.
Reducing death taxes is a complicated matter and this article does not attempt to cover every tax issue in estate planning. At a minimum, your estate plan should deal with all the issues mentioned above. If it doesn't, you owe it to yourself and your family to review your estate planning.
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Lawrence J. Peck is a New York City attorney specializing in estate planning and wealth preservation. He has 30 years experience in advising clients on estate planning and taxes and has authored numerous articles for estate planning publications. You can contact Larry through his website http://estateplanningnewyorkgroup.com