Estate and Gift Tax Planning

1. Estates and gifts are taxed using a unified rate schedule from 37% to 55%.
 

2. Each person has a credit, known as the applicable credit amount (previously the unified credit), that is currently the equivalent of a $675,000 exemption from federal estate and gift tax (" the applicable exclusion amount"). Thus, the first $675,000 of property transferred is exempt from tax. The applicable exclusion amount will gradually increase over the next seven years as follows:
 

2000 and 2001 - Exemption to $675,000
2002 and 2003 - Exemption to $700,000 2004 - Exemption to $850,000
2005 - Exemption to $950,000
2006 - Exemption to $1,000,000, indexed annually for inflation thereafter

3. There is a generation skipping tax (GST) assessed on gifts and bequests that skip a generation. The first $1 million transferred is exempt from the GST. Beginning in 1998, the amount is indexed annually for inflation.
 

4. Annual $10,000 Exclusion

1. An individual can make annual $10,000 gifts to any number of persons without incurring gift tax. This is $10,000 per donor to an individual donee. Beginning in 1998 this amount is indexed annually for inflation.
    
2. Married persons can combine their $10,000 per year exemption to give away $20,000 to each donee, regardless of whether the assets being given are in the name of the husband, wife or both. These annual gifts are not counted against the $650,000 (in 1999) exemption detailed above.
    
3. Gifts must be a present -- not future interest.

5. New York State Estate and Gift Tax

1. The NY gift tax was repealed as of January 1, 2000. The NY estate tax became a "sop" or "pick-up" tax after February 1, 2000. This means that the NY estate tax is now equal the amount of the allowable federal credit for state death taxes pursuant to the Federal estate tax return.
2. The personal residence deduction is repealed effective for decedents dying after January 31, 2000.  
3. Ramifications and Considerations

1. As of February 1, 2000, there will be no requirement to obtain estate tax waivers and no requirement to file a NY estate tax return with the Surrogate Court (although the Surrogate may require the filing of the federal return).
    
2. Traditional drafting for funding of the so-called "credit shelter trust" created under a Last Will and Testament should be revisited in light of the NY "sop" tax. Either no use of the state death tax credit should be made, or discretion should be given to the executor to consider the appropriateness of its use, given the increased cost of such.

B. A Few Basic Rules of Estate Planning

1. Unlimited Marital Deduction

1. An individual can leave any amount to his or her spouse and there will be no federal estate tax when the first spouse dies (there may be some New York Estate Tax for decedents dying prior to February 1, 2000). However, this does not mean that spouses should leave everything to each other where there could be a taxable estate at the death of the surviving spouse.

2. The Credit Shelter

1. As a result of the applicable exclusion amount, in 1999 an individual can leave $650,000 to a non-spouse and there is no tax (this is often referred to as the "credit shelter amount").

3. The Credit Shelter Trust

1. Basic estate tax planning can exempt $1,350,000 (in 2000) from federal estate tax. This is accomplished by leaving $675,000 in a "credit shelter trust" (also known as a "by-pass trust") for the benefit of the surviving spouse.
    
2. The surviving spouse receives income, and principal invasions if necessary for support, education, welfare and maintenance (invasions are allowed to the extent of the greater of $5,000 or 5% of the principal per year) from the trust. At the death of the surviving spouse, the trust principal is distributed to the children (or any other designated beneficiaries). At the death of the surviving spouse, the trust amounts from the first estate are not considered owned by the now deceased surviving spouse. Thus,the trust principal is not included in the surviving spouse's gross estate.
    
3. Splitting assets between husband and wife also makes sense. Spouses should each have at least $675,000 in their individual names so each fully utilizes the applicable exclusion amount.

4. Is It Better To Make A Gift During Lifetime Or To Transfer Assets At Death

1. The greatest advantage of a lifetime gift is that a gift of property removes future appreciation from the estate. This is obviously most valuable where the asset is likely to appreciate significantly.
2. The most significant disadvantage of a lifetime gift is that the recipient of the gift inherits the basis of the person making the gift.
3. The greatest advantage of transferring property at death is that the recipient at death receives a stepped-up basis at death. "b" and "c" can be illustrated as follows:
    

1. Example: At her death, Susan owned stock with a basis of $2,000 and a value of $50,000. Because the stock is included in Susan's estate, it's basis is stepped-up to $50,000. Thus, her heirs can sell the stock immediately for $50,000 and pay no tax. In the alternative, however, if, prior to death, Susan gifted the stock with a current fair market value of $50,000, and Susan's basis was $2,000, if the recipients of her gift immediately sold the stock for $50,000,they would pay capital gains tax on $48,000 of gain.

5. Irrevocable Life Insurance Trust (ILIT)

1. Life insurance proceeds (the death benefits) are taxable in an insured's estate.
2. 
   To avoid inclusion, planners often recommend the creation of an ILIT and have the trustees of the ILIT own the life insurance on the life of the insured.
    
3. The insured makes a gift to the trustees each year in an amount at least sufficient to pay the premium.
    
4. The ILIT would provide income, and principal invasions when necessary, for the benefit of the spouse (same basic strategy as in a credit shelter trust). At the death of the spouse, the children receive the assets of the ILIT.
    
5. Thus, on the insured's death, there is no tax because the insured did not own the life insurance asset, and the same is true at the death of the spouse.
    
6. The life insurance trust is designed to accept life insurance death benefit proceeds on the death of the insured.
    
7. The trustee of such a trust, usually named as beneficiary on the life insurance policy, uses the proceeds for the specific purposes and objectives of the insured, which is very often to provide liquidity, pay administrative expenses and estate taxes upon death of the insured.
    

(i) This can be accomplished in many ways. Very often, the Trust will purchase assets from or loan money to the estate of the insured.

8. The Internal Revenue Code provides that proceeds from a life insurance policy moved to a trust (or otherwise transferred) within 3 years of the date of death will be brought back into the estate. Therefore, any new policies purchased after the creation of the irrevocable life insurance trust should be purchased by the trustee of the trust rather than the insured to avoid possible inclusion in the insured's estate. (When an insured transfers an existing policy, the grantor must outlive the transfer by 3 years in order for the proceeds to escape estate taxation.)
    
9. The irrevocable transfer of an insurance policy constitutes a gift. Generally, the gift is measured by the replacement cost of the policy. The $10,000 annual gift tax exclusion is available, provided the Crummey withdrawal provisions are included in the Trust and followed.
    

(i) Crummey withdrawal provisions are beyond the scope of this lecture. But generally provide to make a gift of an otherwise future interest into a gift of a present interest which then qualifies for the $10,000 annual exclusion.

Bluestein & Muhlbauer, P.C.
333 International Drive
Williamsville, NY 14221
716.633.3200

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