Contrary to McLaughlin’s statement, a big change in the federal estate tax arena has arrived that will make it possible to leave a bit more behind than in previous years. This change, part of the 2001 Tax Act, may make it advisable for you to review and perhaps revise your estate plan.

As of January 1 of this year, the Applicable Credit Amount (sometimes called the “Unified Credit”) almost doubled, from $2 million to $3.5 million. The Applicable Credit Amount is the amount of property that can pass from your estate to your beneficiaries without estate tax. While that is
good news, this increase may result in distributions from your estate that are different than what you intended, because many, if not most, wills use the Applicable Credit Amount to calculate the value of certain bequests. As an illustration, look at the following example:

H and W have been married for 20 years. The marriage is the second for both of them. H has two children from his first marriage, and an estate of $5 million. H’s estate planning goal is to provide for W, but still leave something for his children. He is comfortable with each child receiving $1 million. To achieve that goal, H’s will currently provides that a portion of his estate equal to the Applicable Credit Amount will go to trusts for his children. The remainder of his estate will pass outright to W.

“Philosophy teaches a man that he can’t take it with him; taxes teaches him he can’t leave it behind either.” — Mignon McLaughlin

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As a result of the change in the law, the amount that goes to W has been cut in half! If that result is not what H intended, he needs to amend his estate planning documents so that he achieves his estate planning goals.

However, the increase in the Applicable Credit Amount is temporary. Under current law, there will be no federal estate tax in 2010, but the 2001 Tax Act “sunsets” on January 1, 2011, so unless Congress acts to change the law, the federal estate tax will revert to its pre-2001 level, with a $1-million Applicable Credit Amount and a top estate tax rate of 55 percent.

Other Changes in 2009

1. Annual exclusion from gift tax. The annual exclusion from gift tax is the amount of property each person can give to another without gift or estate tax consequences. That amount, previously $12,000 per person per year, increased to $13,000 on January 1.

2. Transfers to non-citizen spouses. In 2009, the amount of property that may be transferred without gift tax consequences to a non-citizen spouse increases from $128,000 to $133,000 per year.

Changes that are Being Discussed for 2009 or Later

1. Elimination of intra-family “discounts.” For a number of years, a popular estate planning technique that many families have utilized is the transfer of assets from the senior generation to younger generations by using a family limited partnership (“FLP”) or a limited liability company (“LLC”). This technique is especially useful for assets that are difficult to divide, such as real estate. By putting such an asset in a FLP or LLC, parents can simplify gifts by transferring interests in the FLP or LLC, instead of the property itself, to younger generations. When gifts of such interests are made, the value of the gift is the fair market value of the non-voting, minority interest in the entity, which often
represents a discount from the value of a pro-rata share of the underlying assets. There is some chance that Congress will try to eliminate such discounts for interests in family entities that do not actually conduct business with the public.

2. Elimination of Crummey Withdrawal Powers. The annual exclusion from gift tax, discussed above, does not apply to gifts of future interests in property. A “future interest” gift is one in which the use, possession or enjoyment of the property is postponed to a future date. Most gifts to a trust constitute future interests. If the beneficiary of the trust, however, has a power, called a Crummey Withdrawal Power, to demand a current distribution of the property contributed to the trust, the gift will be viewed as a “present interest” gift, thereby qualifying for the annual exclusion. There has been some discussion about eliminating Crummey Withdrawal Powers, thereby excluding gifts to trusts from qualifying for the annual exclusion from gift tax.

3. Increase in the capital gains tax rate, from 15 percent to 20 percent or higher. President Obama has called for an increase in the capital gains tax rate. Experts believe that the possibility of a rate hike is very likely.

These scheduled or potential changes create uncertainty in the federal estate tax arena. Careful planning will be necessary to achieve the best tax results for your family.