ESTATE TAX BASICS

Whether its income, sales, capital gains, or property taxes, all of us have to deal with taxes in some form or another. After all, April 15th would not mean anything if it weren't for taxes. It doesn't matter if it's a flat tax, graduated tax, or an upside down tax... taxes are the largest expense and a major problem for us all.

Taxes play a large factor in developing an effective estate plan, and eventually funding it. The largest tax bill, unfortunately, comes when you are long gone and have already become an angel... that's the day your estate taxes are due.

The 50% Estate Tax

Estate taxes? Don't we pay enough in taxes? Yes we do. In fact, according to one Washington think tank, the average American spends more paying taxes than buying food, tobacco, clothing, and housing combined.

One of our never-ending goals is to minimize taxes as much as possible, preserving wealth for yourself and loved ones. That goal does not changed when it comes to effective estate planning.  And with good reason. Estate taxes (which mirror gift taxes) can get much higher than your personal income tax ever did, with rates climbing as high as 50%!

This is how the IRS calculates your estate tax bill:

By using the tax chart, you can estimate what your estate taxes will be. For instance, suppose you have an estate worth $2.1 million. With the above chart, you would fit between the $2,000,000 and $2,500,000 category.

Your estate tax equals $780,800 for the first $2 million, plus 49% tax on the leftover:

Estate Taxes = $780,800 + $100,000(0.49) = $829,800

Skipping a Generation Can Be Costly

When you gift over $1 million to grandchildren (effectively "skipping" a generation), the IRS slaps a double tax on you. In fact, the IRS treats such a gift as "two gifts in one" and slaps a 55% tax on the gift twice. When such a gift is hit once with a 55% tax... and then again with another 55% tax, the gift is effectively reduced by 80%! That means $1 million of your hard-earned wealth immediately shrinks to $200,000 for your heirs, with the remainder going to Uncle Sam.

There Is Some "Unified" Relief

Congress has created what it called the "Unified Credit" (also known as the Unified Federal Gift and Estate Tax Credit). The Unified Credit allows every American citizen to pass a certain amount of their estate to heirs tax-free. This credit can be used during one's lifetime (e.g. a businessman wishes to gift his daughter $1.5 million), but is usually used after someone has died and the estate is being distributed.

With the Taxpayer Relief Act of 1997 and the Tax Relief Act of 2001, the Unified Credit has gradually been increasing. In addition, the top estate tax rate will be decreasing until 2010, when estate and gift taxes are fully repealed. However, in 2011, estate taxes return to their 2002 levels.

Here's a breakdown of the new Unified Credit and top estate tax rates:

In 2004, every estate holder who dies can pass $1.5 million of their estate tax-free to heirs.  Unfortunately, the remainder is subject to estate taxes. 

• Married couples, with proper planning, can pass up to $3 million dollars.

• An Irrevocable Life Insurance Trust may eliminate additional, if not all other estate taxes.

Estate taxes are due to the IRS only 9 months from date of death. In many cases, heirs and loved ones are forced to sell personal property, real property, and other belongings at below market value to pay for this huge tax bill.  Reducing Taxes Is Critical Planning is a must. Many people with large estates, who create a simple living trust, often overlook their largest tax liability (and they won't even be around to pay it).