Q. What is the difference between a will and an estate plan?
A. While a will can be simply described as a document through which an individual provides for the distribution of his or her property upon death, estate planning usually refers to the complex advice and document drafting associated with tax-advantageous vehicles for disposing of one's assets in light of and/or upon one's future demise.
Q. When is an "estate plan" necessary as compared to simply drafting a will?
A. Estate plans that utilize means other than a will to dispose of one's assets are beneficial in circumstances where, because of the size of one's estate, one may have to pay substantial taxes upon death. Estate plans may also be necessary for a variety of other reasons, such as the need to provide for more than one family, concerns over an individual's ability to manage money or other reasons.
Q. Can I actually avoid paying estate taxes through the use of an estate plan?
A. Absolutely. Some or even a substantial portion of both federal estate taxes and state estate taxes may be able to be avoided through a properly drafted and implemented estate plan.
Q. What are some examples of tools for avoiding the payment of estate taxes?
A. One of the primary vehicles for avoiding estate taxes is the use of what are known as "trusts." A trust, which is effectively a legal document that conveys a property interest during one's lifetime from one individual to one or more individuals, known as beneficiaries, enables the "settlor" of the trust to provide direction for the management and distribution of such property as specified by the trust document. A trustee is appointed to independently manage the assets of the trust in accordance with the specified terms of the trust.
Q. Does the establishment of a trust avoid all taxes?
A. No. Gifts provided through a trust are still subject to federal gift taxes to the extent that they aren't exempted from gift tax in other ways.
Q. You indicate that there are exemptions from federal estate and gift tax in some instances. What are those exemptions?
A. Under federal law, a portion of each individual's estate is excluded from paying federal estate tax. For the years 2004 and 2005, the applicable exclusion amount, including any lifetime gifts is $1.5 million. This exclusion amount will increase to $3.5 million in 2009 and the estate tax will be repealed in 2010. However, the law will expire at the end of 2010 and, unless Congress passes a new law, the estate tax (55%) and exclusion amounts ($1 million) in effect prior to 2001 will be reinstated if no new law is implemented before the end of 2010.
Q. Are you saying that if my estate is worth less than $1.5 million in 2004 that I won't have to pay any federal estate taxes if I die in 2004?
A. To the extent that your non-excluded lifetime gifts and the balance of your estate amount to less than $1.5 million (known as the "applicable exclusion amount"), then you will not be subject to federal estate tax.
Q. By the same token, are you saying that anything I own in excess of the applicable exclusion amount will be subject to federal estate tax?
A. To the extent that your estate, including any lifetime gifts (in excess of applicable exclusion amounts), amounts to more than $1.5 million, if you die in 2004, that portion of your estate will be subject to federal estate tax. However, the portion of your estate in excess of the applicable exclusion amount that passes to your spouse will not be subject to federal estate tax until your spouse dies as well, to the extent your spouse possesses assets in excess of his or her applicable exclusion amount at that time. This is known as the federal marital deduction. Similarly, any property passing to a spouse is not subject to Pennsylvania state estate taxes.
Q. If my spouse and I hold all of our assets jointly and they pass at death as a matter of law and not through the estate, will I be able to take advantage of the applicable exclusion amount?
A. No. Where a couple has substantial assets exceeding the applicable exclusion amount, one of the most important aspects of estate planning is to create separate estates for each individual. If all of the property passes to one spouse by operation of law and not through the estate, the applicable exclusion amount will be lost for the first spouse to die.
Q. If I have assets that exceed the applicable exclusion amount, will my estate have to pay estate taxes on the difference upon my death?
A. If all of your assets are left to your spouse, your estate will not have to pay estate taxes upon your death. However, to the extent that you convey property to others that exceeds the applicable exclusion amount, your estate will have to pay taxes upon your death.
Q. What if I want my spouse to receive the income from my assets but I want to leave the assets to my children or grandchildren, will my estate have to pay estate taxes on those assets upon my death?
A. If your will gives your spouse what is called a "general power of appointment" over the assets during his or her lifetime or if it creates what is known as a "Qualified Terminable Interest Property (or QTIP) Trust," then you can keep your estate from paying taxes during the life of your spouse. However, the remainder will be taxable upon your spouse's death?
Q. Isn't it wise to leave all of my property to my spouse so that she can take advantage of the unlimited marital deduction?
A. Not necessarily. If your spouse is your only desired beneficiary or if you wish your spouse to do as she wishes with the balance of your estate, then this may make sense. However, if all of your property is left to your spouse, then you will not be able to take advantage of the "applicable exclusion amount," and your spouse's estate, upon his or her death, will have to pay taxes on everything except his or her "applicable exclusion amount." By passing a portion of your estate as "non-marital property," you can take advantage of your "applicable exclusion amount," thus avoiding substantial estate taxes, and then, if you wish, leave the balance of your estate to your spouse to take advantage of the unlimited marital deduction.
Q. Does it make sense then to leave everything but the "applicable exclusion amount" to my spouse upon my death?
A. This, of course, depends upon the amount of the assets involved, how you wish to distribute your property, as well as on any tax-advantageous vehicles for distributing your assets.
Q. Well, if I want to pass a portion of my assets to my children or grandchildren, are there ways other than the "applicable exclusion amount" and the unlimited marital deduction to avoid paying estate taxes?
A. Yes. One of the best ways to distribute your property is to distribute it during your lifetime. When you distribute it during your lifetime, it is, of course, not subject to estate taxes. However, it is subject to gift taxes to the extent that what you distribute is considered a gift and is not otherwise exempt.
Q. You mean I have to pay taxes when I give someone a gift?
A. Other than gifts to your spouse and charitable organizations and some other limited exceptions, if your gift to any individual exceeds a specific amount - $11,000 in 2004 - in any calendar year, then you must pay gift tax. Excluding the annual exemption, if the gifts you give during your lifetime exceed $1 million, you will be subject to gift tax and the applicable exclusion amount for estate tax purposes will be reduced accordingly.
Q. So I can give $11,000 per year to any and every individual I like without having to pay taxes on it and without it reducing the applicable exclusion amount for estate tax purposes?
A. Yes. Also, if you are married, when you and your spouse give a gift of your community property, you can give an annual gift to any and every individual of $22,000 without it being subject to gift tax. And if you have a married child, you can make a $22,000 gift each to your child and their spouse each year. There are other exclusions from gift tax, such as for the payment of school tuition, that are important to know as well.
Q. Annual gifts seem to be a great way to dispose of my assets without incurring taxes. Are there any drawbacks to the gift tax?
A. Certainly, the annual limitation on exempt gifts is a significant drawback in that it prevents the transfer of certain large items of property, such as a home, without incurring gift taxes. Otherwise, gifts are an excellent way to dispose of one's assets without incurring taxes, assuming one lives long enough to dispose of sufficient assets in this way.
Even in the event that a lifetime gift exceeds the annual exclusion amount and tax must be paid on it, lifetime gifts still provide certain tax benefits as compared to the payment of estate taxes. This is because of the manner in which tax is computed on a gift as compared to the computation of tax on an estate. When tax is computed on a gift, only the gift is taxed. Thus, a gift of $100,000 in excess of the exempt amount, if taxed at a 55% rate, would require the payment of $55,000 in taxes. However, if a bequest in the same amount were made, tax would be computed based on the amount of the estate that was necessary to pay the tax. Thus, to make a $100,000 bequest, an estate would need $222,222 ($100,000 gift and $122,222 in taxes ($222,222 x 55%)) since the tax would be computed based on the amount in the estate necessary to give the gift.
Q. I've heard that life insurance can be an excellent way to avoid taxes since life insurance proceeds are not taxed. Is that right?
A. Life insurance proceeds are generally not taxed for income tax purposes. However, they are taxed for estate tax purposes if the owner of the policy is the decedent or the decedent continued to possess "incidents of ownership" to the property and the beneficiary is someone other than the spouse. No estate taxes are applicable if the proceeds pass to the spouse and are, therefore, shielded from tax by the unlimited marital deduction. Except for the spouse, only if someone other than the decedent is the owner of the policy can the proceeds avoid estate taxes.
Q. If I want my children to be the beneficiaries of life insurance and I don't want it to be subject to estate taxes, is there anything I can do?
A. If the assets in your estate, excluding life insurance, exceed the applicable exclusion amount, you may want to consider, as another means of estate planning, the establishment of a life insurance trust or other vehicle for passing assets to your children. With a life insurance trust, the proceeds of life insurance and all incidents of ownership are held in the trust and, therefore, there are no estate taxes, as well as no income taxes on the proceeds. Of course, once the proceeds are invested, there are income taxes on the income from the proceeds.
Q. Why would I want to use a life insurance trust as an estate planning vehicle rather than lifetime gifts, a bypass trust, or other estate planning vehicle?
A. There are a number of reasons. First of all, of course, proceeds of life insurance that are realized by a life insurance trust will not be subject to any income or estate taxes regardless of the beneficiaries if the life insurance trust is properly set up. Second, like any trust, a life insurance trust can be designed so as to direct the Trustee to utilize the proceeds as specified. Of course, lifetime gifts can also be placed in trust, but the amount of such lifetime gifts is severely limited.
Q. How is a life insurance trust funded if the insured is not the owner?
A. There are a variety of vehicles for funding a life insurance trust
Q. What if I purchase an annuity. Can I avoid income and estate taxes on the annuity payments?
A. Depending on the type of annuity, A portion of every annuity is taxable
Q. Can an attorney represent both my spouse and me in connection with either of our estate plans?
A. While it is common and not inappropriate per se for attorneys to represent more than one party in connection with an estate plan, conflicts of interest may result from joint estate planning. An attorney should determine, therefore, whether a consultation with two individuals may adversely affect his or her ability to represent one or the other client, and should refrain from the representation if representation of one spouse will "materially limit" representation of the other spouse. If the attorney believes that conflicts can be avoided, parties seeking joint consultation with an attorney should agree in advance to the joint consultation and to full disclosure of all information gathered from any party during such joint consultation. Under these circumstances, the attorney has a duty to apprise each client of the ramifications of each approach to estate planning. A joint representation agreement should be signed which specifies each of these objects.
Q. What information will an attorney need in preparation for drafting a will or an estate plan?
A. Your attorney will need you to provide information about your assets and debts, life insurance, pension plans, and any other financial information, as well as specifics about your marriage or marriages, your children, and your intended beneficiaries. All of this information is necessary to properly draft a will or plan your estate.
Q. How much will it cost me to have a will drafted or prepare an estate plan?
A. A simple will that has no tax or more complicated planning associated with it should cost a relatively small sum. At Berger Law Firm, P.C., we charge $200 for a simple will, which includes the cost of an initial consultation with you to gather the necessary information, drafting of the will, a further meeting to explain the contents of the drafted will, one opportunity for modification if necessary, and a final meeting to execute the document. Hours of work on your estate that are necessary above and beyond these limitations we charge at $70 per hour.
Disclaimer: These materials are not intended as legal advice and should not be used as a substitute for consultation with an attorney. This material is provided for general informational purposes only, and may not reflect current legal developments, verdicts or settlements. Legal and business transactions should not be undertaken based solely on this material. Individuals and businesses should consult with a licensed attorney in the appropriate jurisdiction for consultation with respect to estate planning and should not rely on these materials as the basis for an estate plan.
