The Estate Planner

ESTATE AND GIFT TAX LAW CHANGES PROVIDE PLANNING OPPORTUNITIES

Congress recently passed the Tax-payer Relief Act of 1997 which includes numerous changes in the tax laws including reductions in the rate of tax on long term capital gains to a maximum rate of 20%, individual retirement account enhancements, education tax breaks, and exclusion of gain on the sale of a principal residence up to a maximum of $500,000 on joint returns, among other tax payer relief provisions, together with some very significant changes in the estate and gift tax law.

The changes in the estate and gift tax laws will afford taxpayers many opportunities to lessen the gift and estate tax burden placed upon their appreciating assets. The following are highlights of the estate and gift tax law changes under the Taxpayer Relief Act of 1997:

Increase in Unified Credit

At present, a unified estate and gift tax credit of $192,800 exempts the first $600,000 of cumulative transfers. Beginning in 1998, the effective exemption is gradually increasing until it reaches $1,000,000 in 2006. The unified credit will provide an effective exemption of $625,000 for decedents dying and gifts made in 1998; $650,000 in 1999; $675,00 in 2000 and 2001; $700,000 in 2002 and 2003; $850,000 in 2004; $950,000 in 2005; and $1,000,000 in 2006.

Transfer Tax Indexing

After 1998, the $10,000 annual gift tax exclusion, the $750,000 ceiling on special use valuation, the $1,000,000 generation-skipping transfer tax exemption and the $1,000,000 ceiling on the value of closely held businesses eligible for the special lower interest rate will be annually indexed for inflation. However, there is no provision for indexing the effective unified credit after it raises to $1,000,000 in the year 2006.

Estate Tax Exclusion for Qualified Family Owned Business

Generally, if an individual dies after 1997 and more than 50% of his or her estate consists of qualified family owned business interests, the personal representative may elect to exclude up to $675,000 in value of the interests from the individualâs gross estate. However, this maximum exclusion is reduced each year because the exclusion may not exceed the excess of $1,300,000 over the unified credit exemption equivalent. Therefore, an electing estate is limited to a total of $1,300,000 of exemption by use of the unified credit and the exclusion for qualified family owned business interests.

Installment Payments of Estate Tax on Closely Held Business

A decedentâs estate can generally elect to pay estate tax attributable to a closely held business interest in installments over a maximum period of 14 years. If the election is made, the estate would pay interest only for the first 4 years and then 10 annual installments of principal and interest. A special 4% interest rate would apply to the first $1,000,000 in the value of the closely held business interests. For individuals dying after 1997, a special 2% rate applies for the deferred estate tax attributable to the first $1,000,000 in taxable value held of the closely held business interests ($1,000,000 in value of the closely held business interests above the effective exemption provided by the unified credit). This is extremely beneficial for a decedentâs estate compared to the prior law which effectively provided a 4% interest rate for only $400,000 of taxable value of the closely held business interests. The effective interest rate on the deferred estate tax attributable to the taxable value of the closely held business interests in excess of $1,000,000 is reduced to an amount equal to 45% of the rate applicable to underpayments of tax. However, the interest paid under this installment procedure is no longer deductible for estate or income tax purposes.

Repeal of Excess Distributions and Excess Retirement Accumulations Tax

The 15% excess distributions tax applied to retirement plan funds is repealed effective with respect to distributions received after 1996, and the 15% excess accumulations tax imposed at death on retirement plan funds is repealed effective with respect to decedents dying after December 31, 1996.

Limitations on charitable Remainder Trust Eligibility

For transfers made to a charitable remainder trust after June 18, 1997, a charitable remainder trust cannot have an annual payout rate in excess of 50%. Further, for transfers made to a charitable remainder trust after July 28, 1997, the charitable remainder interest must be worth at least 10% of the entire asset value being transferred to the trust.

Gifts made from a Revocable Trust within Three Years of Date of Death

Transfers made directly from a revocable trust will be treated as if made directly by the settlor of the trust, therefore, the transfer will not be subject to the three year rule. Under prior law these gifts would be included in the decedentâs estate if he or she had died within three years of making the transfer from the revocable trust.

The brief summaries provided above do not contain all of the changes and complex provisions which are part of the new Act and which may be beneficial to you. It is advisable to consult with a professional who specializes in the area of estate planning to determine whether or not any of these changes may affect your particular situation.

THE BENEFITS OF CHARITABLE REMAINDER TRUSTS

Dramatic savings in taxes as well as an enhancement of retirement benefits and wealth passing to your heirs can be achieved through the use of a charitable remainder trust in conjunction with an irrevocable life insurance trust. Charitable remainder trusts can be used as a supplement to your existing retirement plan, providing additional retirement benefits, while reducing or eliminating capital gains taxes. Further, any transfer to a charitable remainder trust, which will ultimately pass to a charitable remainder beneficiary, can be replaced through the purchase of life insurance, the proceeds of which can pass free of estate tax to your family members through the use of an irrevocable life insurance trust.

A charitable remainder trust allows you to make a contribution to charity while retaining an interest in the gift or transfer and receiving a charitable deduction for the assets ultimately passing to the charitable organization. A charitable remainder trust must provide for payment of either an annuity amount or a unitrust amount (a percentage of the value of the trust each year) to specified non-charitable beneficiaries during their lifetimes or for a period not to exceed 20 years with the remainder passing to charitable organizations as defined under Section 170 (c) of the Internal Revenue Code of 1986, as amended (the "Code"). The annuity amount must equal at least 5%, but not in excess of 50%, of the initial value of the assets passing into the trust and the unitrust amount must be at least 5%, but not in excess of 50%, of the value of the assets as determined on an annual basis. A unitrust may pay the lesser of the net income of the trust and the unitrust amount annually and also contain a "make-up" provision allowing the use of excess income in later years to make up any deficiencies in the distribution of the actual unitrust amount in previous years. Further, the charitable remainder interest must be worth at least 10% of the value of the assets being transferred to the charitable remainder trust.

With respect to a charitable remainder trust created during oneâs life, the grantor of the trust is entitled to a charitable income and gift tax deduction for the fair market value of the remainder interest of the trust. To the extent any of the beneficiaries of the annuity or unitrust amounts are other than the grantor, then the value of the interest is subject to gift tax. If the non-charitable beneficiary is the grantorâs spouse, then the marital deduction is allowed under Section 2523(a) of the Code [see Section 2523(g) of the Code]. At the death of the grantor (or at the death of the grantorâs spouse), when all non-charitable interests terminate, and the assets pass to the charitable remainder beneficiaries, an estate tax deduction is allowed for the value of those interests passing to charity under Section 2055 of the Code.

A charitable remainder trust is not subject to any income tax unless it has unrelated business income. Thus, if you are nearing retirement age and the funds contained in your existing retirement plan are inadequate for your future retirement needs, and if you hold any low basis assets outside your retirement plan funds, you have the opportunity of transferring those low basis assets to a charitable remainder trust and liquidating those assets to allow for a diversification of the proceeds into higher income yielding assets, without incurring any capital gains tax. As the grantor of the trust, you can retain an interest in the trust for your life in an annuity amount or unitrust amount as described above, to enhance the amounts distributed from your retirement plan. As assets are distributed from the charitable remainder trust, you would be taxed on those distributions in accordance with a tier system of income taxation.

Further, as mentioned above, you would be entitled to a charitable deduction for the contribution of the assets to the charitable remainder trust equal to the value of the remainder interest which would ultimately pass to charity. There are certain limits to the taking of a charitable deduction in any one calendar year depending upon whether the charitable organizations are a public or private foundation, whether the type of property contributed is long-term capital gain property and the amount of your adjusted gross income in any one taxable year. The deduction ceiling is generally 50% of a taxpayerâs adjusted gross income. If long term capital gain property is contributed to a charitable remainder trust, the deduction ceiling would be 30% of the taxpayerâs adjusted gross income. However, the taxpayer may make use of a charitable deduction carry-forward which is available for use in future taxable periods.

Under a charitable remainder trust, because the property will ultimately pass outside the family to charitable organizations, there may be a need to replace the funds lost to the family with life insurance on the grantorâs life (or a combination of the lives of the grantor and the grantorâs spouse). If you have achieved an enhancement of income from a charitable remainder trust as described above, some of this excess income can be utilized in the payment of premiums on life insurance which will mature at the termination of the charitable remainder trust and pass an equivalent amount of assets to family members without incurring additional estate tax. This can be achieved by creating an irrevocable life insurance trust which will own the policies of life insurance which are being used to replace the wealth loss. If the insured holds no incidents of ownership in the policies, then the proceeds of the insurance policies will not be included in the taxable estate of the insured. Further, the amount passing to the insuredâs heirs could actually be greater than the amounts passing to charities depending upon how much insurance coverage could be purchased by the increased cash distributions from the charitable remainder trust.

Charitable remainder trusts used in conjunction with wealth replacing irrevocable life insurance trust can provide substantial benefits in increasing retirement income as well as assets ultimately passing to family members while providing significant benefits to your favorite charities.

THE ADVANTAGES OF REVOCABLE LIVING TRUSTS

When most people think of directing how their assets will pass at their deaths, they think of the need to execute a Will. However, depending upon the extent and complexity of a personâs assets, a Will may not be the most beneficial testamentary document to use. A Revocable Living Trust, created during your lifetime, to which you transfer the bulk of your assets, provides a number of advantages.

Avoidance of Probate

A Revocable Living Trust can avoid probate, which is the court-supervised process for the management and distribution of your estate at death. Probate, in most cases, is a time consuming and costly court procedure consuming as much as 5% of the value of your estate. If a Revocable Living Trust has been established during your lifetime, there are no time delays in administering your assets at death. The successor trustee named under your living trust can immediately step in to manage your assets for the benefit of your family members under the terms of the trust document.

Avoidance of Ancillary Probate Proceedings

In the event you own property outside your state of residency, this property may be subject to ancillary probate proceedings in the state in which the property is located. Again, this can be a time consuming and costly procedure. Transferring this property to your Revocable Living Trust can avoid these ancillary probate proceedings.

Avoidance of Guardianship Proceedings

In the event you should become incapacitated and cannot manage your own financial affairs, if your assets are in a Revocable Living Trust, there will be no need to establish a separate guardianship for your benefit. Your successor trustee can assume control of your assets at that point in time and manage them for your benefit as long as your incapacity lasts. Guardianship can severely strain family relationships and again, they can be a costly process. Thus, the assistance a Revocable Living Trust can provide in avoiding guardianship proceedings is extremely worthwhile.

Avoidance of Public Scrutiny

Probate proceedings are generally open to public scrutiny. Avoiding the probate process by use of a Revocable Living Trust can provide privacy to you and your family members.

The advantages afforded by a Revocable Living Trust, including significant cost savings in the administration of your estate and the promotion of efficient management of family assets both during your lifetime and after your death, make its use highly desirable in a number of estate planning contexts.

EDITOR Debra K. Smietanski

Debra K. Smientanski, a partner with Broad and Cassel, is a Florida Bar Board Certified Wills, Trusts and Estates attorney. Ms. Smientanski is a graduate, cum laude, of the University of Illinois School of Law and is a Certified Public Accountant.

The Estate Planner offers timely and practical information, and should not be considered as legal advice as to any specific matter or transaction. The hiring of a lawyer is an important decision that should not be based solely upon advertisements. Before you decide, ask us to send you free written information about our qualifications and experience.

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