 WICHITA, KANSAS Estate Planning Under the 1997 Tax Relief Act Many individuals review their estate plans at the beginning of each new year. Because 1997 was a year of significant change to certain provisions of the federal estate and gift tax laws, we felt it would be appropriate to highlight some of those changes for you. Most of the developments are the result of the 1997 tax legislation enacted by Congress, the Taxpayer Relief Act of 1997 ("Act"). This Newsletter is not intended to provide an in-depth explanation and analysis of the Act and its consequences to your personal estate plan, but rather to simply highlight the most important federal estate and gift tax provisions of the Act and discuss how those provisions might apply to the most common estate planning situations. Important changes made by the Act include: Increase in the Exemption Amount Prior to 1998, each individual had an exemption of $600,000 in the amount of property he or she could give away before death and/or own (for tax purposes) at death before the imposition of a gift or estate tax. The Act increases this exemption gradu-ally over a period of years. The $600,000 exemption amount becomes $625,000 in 1998; $650,000 in 1999; $675,000 in 2000 and 2001; $700,000 in 2002 and 2003; $850,000 in 2004; $950,000 in 2005; and finally $1,000,000 in the year 2006. What does this increase mean to your planning? Obviously, the increase reduces the potential estate and gift taxes as the exemption amount increases are phased in. Note, however, that the exemption increases are "back loaded". The exemption only increases $100,000 in the first 6 years. Increases in the underlying value of stocks, bonds, and other assets may well offset the projected increases in the exemption amounts. Do you need to make any changes to your Will or Trust because of this increase? The answer is probably not. The single most common estate planning technique utilized by married couples concerned about estate taxes is to split property between the husband and wife (so each owns approximately one-half of the total property) and then create a "bypass" or "family trust" share funded with the amount equal to the remaining estate tax exemption. The property in this "bypass" trust share can then pass, at the death of the surviving spouse, to your children or other heirs without the imposition of any federal estate tax on the property in such trust share. Increasing the exemption amount does not change the attractiveness of the above technique. If your particular Will or Trust has language which utilizes a formula to calculate the "bypass" share amount, the formula already takes into account the increase in the exemption amount. The formula clauses provide that the "bypass trust" share will be whatever the maximum exemption amount in effect at the time of death is. Thus, instruments that contain such formula clause funding do not need to be rewritten or restated to take into account the planned increase in the exemption amount each year. Individuals should note that by increasing the exemption amount (and thus the amount passing to the "bypass trust" share), a correspond-ing decrease occurs in the amount passing to the surviving spouse (or in trust for such spouse's sole and exclusive benefit during his or her lifetime). Example - Husband and wife have a combined estate of $1,500,000. As step one of their estate planning, they separate their property. Each individual then owns approximately $750,000 in property. As step two of their estate planning, they execute wills which provide that the maximum amount which can pass free of tax will be held in a "bypass" trust share (with the surviving spouse receiving all income for life from such share) and any excess amount then passing outright to the surviving spouse. If death had occurred before 1998, the surviving spouse would have received approximately $150,000 outright and $600,000 would have been held in the "bypass" trust share. For a death occurring in 1998, the spouse would receive $125,000 outright and $625,000 would pass to the "bypass" trust share. For a death occurring in 1999, the spouse would receive $100,000 outright and $650,000 will pass to the "bypass" trust share. If death occurs in 2004 or thereafter, the spouse will not receive any bequest outright. If your particular instrument is drafted with a stated dollar sum bequest (such as $600,000) to the "bypass" trust share, then you should consider the advisability of a codicil or amendment to make reference to the increasing exemption each year if you wish to shelter the maximum property from the federal estate tax. Qualified Family Owned Business Exclusion A new provision was added by the Act designed to reduce the estate tax attributable to an interest in a family owned farm or business. This new exclusion applies to business interests:
The provision is complicated, and the potential benefit of the provision will gradually phase down as the exemption amount increases each year. Nevertheless, in some situations the tax savings can be significant since the potential exclusion amount is $675,000 (in 1998). Individuals with interests in closely held businesses that plan to leave those business interests to other family members at their demise should seek advice to determine the availability of this new tax exclusion to their particular situation. Particular care should be exercised for clients engaged in a regular gift-giving program, to be certain that gifts to family members will not rule out the availability of this exclusion. With the increase in the exemption amount and this new farm and business exclusion, it is possible for a business owner to shelter $1,300,000 from estate tax and a couple to shelter $2,600,000. Gift Tax Returns Have a New Statute of Limitations In the past, unless a large gift was made which required the payment currently of gift tax, there was no effective statute of limitations for taxable gifts. To illustrate, assume an individual gave his or her child an interest in a tract of property in 1997 and filed a gift tax return reporting the value of the gifted property to be $10,000. Because of the availability of the gift tax annual exclusion ($10,000) there was no "taxable gift" and the individual did not reduce his available estate tax exemption or pay any current gift tax. However, when that same individual died (say 5, 10 or even 20 years later), the IRS could argue that the value of the gifted property at the date of the gift was greater, thus increasing the estate tax due at death. A new provision of the Act effectively imposes a three year statute of limitations for gifts made by individuals to family members that are adequately disclosed on a properly filed gift tax return. This change should encourage more people to make more gifts, particularly of "hard to value" property. Gifts of fractional interests in property and gifts of business interests (such as limited partnership interests, corporation stock, etc.) should be more appealing to clients as an estate planning technique. Repeal of the Penalty Tax on Large Pension Accumulations. Individuals with large accumulations in their pension plans, IRA's, 401(k) plans, or similar retirement plans have been faced with a 15% additional excise tax, on top of the normal estate tax, at death. The Act repealed this additional excise tax. Therefore, individuals who were withdrawing significantly more than required from such plans in order to avoid the 15% excise tax at death may wish to rethink the advisability of taking such large distributions. There were a number of other changes in the Act, and we do not intend by this Newsletter to suggest that we are covering all of those changes that are relevant to your particular situation. We encourage each and every individual to periodically review your personal situation and call our office with any questions you might have. The foregoing article has been prepared by Bever Dye, LC, as a service to our clients for informational purposes only and does not constitute legal advice. It is designed to provide general information concerning recent developments and topics of interest in the areas of tax and estate planning law. Do not take action in reliance on items contained in this article without obtaining the advice of an attorney. |