The Death Tax Not Gone
The death tax? Sounds
funny, but it's any thing but. There are still a great number of questions about estate taxes.
Unfortunately, many people believe the sound bites that
have pronounced the death of the death tax.
These have been greatly exaggerated, to say the least.
Many people have the mistaken
impression that the federal estate tax has been repealed. In
reality, the impact of the tax is being substantially reduced over
the next few years, though in 2010 the tax will be
"repealed" for a single year. In 2011 it is scheduled to
return with all its old force.
Death Taxes Still Live
As a result of the Economic
Growth and Tax Relief Act of 2001 ("the Tax Act"),
federal estate taxes will decrease between now and 2010-the top
marginal estate tax rate is gradually lowered from 55 percent to
45 percent, and the amount of money that can be transferred
tax-free gradually rises from $1 million in 2002 to $3.5 million
There is no federal estate tax if
someone dies in 2010, but a "sunset" provision of the
Tax Act basically repeals all its provisions after the end of
2010. As a result, in 2011 the federal estate tax will be back
with a top marginal rate of 55 percent and an exemption equivalent
amount of $1 million.
Of course, Congress could always
act to extend the repeal beyond 2010, but a more realistic
question is whether opponents of the whole idea of repeal of the
"death tax" might be successful before then in
overturning the main provisions of the law.
These are issues that most
Americans are not familiar with but any competent elder law
attorney or estate attorney deals with every day. While it
is important that anyone create a will, people with moderate to
large estates need to be sure that they regularly engage an estate
planning attorney who does a complete review of their finances to
determine what changes have occurred and how they are affected by
any changed tax law.
Keeping Wealth Intact
As Congress fights openly over
the future of the tax, more people are becoming conscious of
estate taxes and their potentially devastating impact. As
trillions of dollars will be passing between the generations over
the next few years, people want estate-planning arrangements that
will help maintain the value of their estates so they can pass on
more of their wealth to their heirs.
In short, estate taxes-both
federal and state-can cripple an estate unless there is a
mechanism in place to pay them. That's where second-to-die life-a
policy expressly designed to pay estate taxes may play a unique
The basic feature of a
second-to-die life insurance policy is that two deaths must occur
before the death benefit is paid. Because the death benefit is not
payable until two people die, the annual premium is much smaller;
permitting a much larger face amount for the same premium outlay
compared to individual life insurance policies on each of them.
What makes a second-to-die life policy a potential fit in paying
estate taxes is the marital deduction, which permits a husband or
wife to leave an unlimited amount of property to the survivor
completely free of federal estate tax.
Regardless of the size of their
estates, the tax of the first to die can always be reduced to
zero. Unless the estates are relatively small, zero taxes upon the
first death will often result in a much higher tax when the second
This isn't to say that a
second-to-die policy is for everyone. As with various trusts
and other financial planning mechanisms, each is created with
certain advantages and disadvantages. Your estate planning
attorney will recommend the most appropriate tax vehicles for your
individual situation and circumstances.
EVERYONE WANTS TO SAVE TAXES, BUT
ONLY UP TO A POINT. While a husband and wife may want to take
maximum advantage of the marital deduction upon the first death,
they may not like the idea of having to set up a trust arrangement
to hold about half of their total assets during the survivor's
lifetime in order to save taxes at his or her death.
At best, the survivor would only
have limited control over these assets, even as to business
interest or real estate in which both took a great deal of
interest during their joint lifetime.
MAINTAINING FULL CONTROL. Rather
than use such tax-sheltering devices, they may prefer to leave
everything to each other outright, even if this increases the
estate taxes due upon the second death.
They may like the idea of a trust
to manage the assets after both of them are gone and the children
are still young-but not for each other.
Recognizing that this will
probably increase the total estate taxes substantially, they
provide the additional cash that the estate may need by taking out
a second-to-die life insurance policy.
Although a second-to-die policy
by itself won't avoid or save estate taxes, it will provide cash
to pay the taxes in an economical and efficient way.
With this approach, parents can
be assured that what they had hoped to pass on to their children
and grandchildren will be used for that purpose.
Tax-Sheltering the Tax Money
Simply buying such a policy is
not enough; the parents want to be sure that the death proceeds
won't be subject to tax in either estate.
Otherwise a policy with a $1
million death benefit, for example, would have an after-tax value
of only $500,000 if the survivor's estate is in a 50 percent tax
But if you set up a properly
designed irrevocable trust and the trust buys the policy, the
death benefit won't be taxed in either estate.
One way to do this is to have the
trust agreement authorize, but not direct, the trustee to use the
death benefit to purchase assets from your or your spouse's
estate, or to lend money to these estates. Thus, if cash is needed
to pay taxes, the death benefit will be available to the executors
without being taxed.
AN IRS RULING. A recent private
letter ruling suggests another way to accomplish this. Here, the
trust agreement, also involving a second-to-die policy, provided
that the trustee was not required to pay any amount of the estate
taxes of the spouse (the one who died last) or use the life
insurance death benefit to satisfy the spouse's debts or
The trustee, however, was given
the discretionary power to pay the estate and other taxes and
estate expenses of either of them, but it was under no compulsion
to do so.
In its ruling the IRS stated that
the insurance proceeds were not subject to tax because they were
not received by the executor of the estate nor was there a legally
binding obligation on the trustee to use them for the benefit of
the estate. (PLR 200147039).
Since this is a private letter
ruling, it is binding on the IRS only as to the taxpayer who
requested it; nevertheless, such rulings are usually indicative of
the position of the IRS.
up the trust agreement requires careful planning with your
attorney. Keep in mind that since the agreement must be
irrevocable, one you fix its terms you cannot change them.