Taxes to Consider for Estate Planning

by : Kris Koonar

No estate tax is payable during 2006, 2007, and 2008 on a descendants estate valued up to $2million. However, estate taxes can chew away a sizable part of the estate after death if effective estate planning steps are not taken in time. A solid estate plan can be made only if one is aware of the effects of estate tax. So let us look at the estate tax structure first. This is important because even a small amount over the exemption limit of $2million would attract a big tax liability as per rules governing estate taxation.

The Internal Revenue Service now calculates estate tax at a flat rate of forty-five percent. This means that if the value of the taxable estate is $3million, 45% of the amount over the exemption limit of $2 million will have to be paid as estate taxes. In this example, it would amount to $450,000. This is a huge amount that can be saved by proper estate planning. It can be passed on to loved ones or serve to support a charitable purpose of one's choice by forming a trust. An estate tax professional would be able to help set up the trust and draft related documents; all for the cost of a few thousand dollars. This is peanuts against paying nearly half a million in estate taxes.

To determine the size of a taxable estate, the value of the gross estate is established. The 'gross estate' would comprise of the value of all the property 'owned' by the descendant at the time of death and would include all property interests also.

Once the gross estate value is fixed, certain deductions are applied to it in order to arrive at the value of the taxable estate. These deductions include the value of funeral expenses paid out of the estate, administration expenses, claims against the estate, eligible charitable contributions, marital deductions, inheritance and state estate taxes (wherever applicable) along with some other deductions.

After the taxable estate is determined, estate tax is calculated at a flat rate of 45% on the amount above $2million. If the size of the taxable estate is below $2 million, no federal estate tax is payable. As indicated above, many states now charge state estate taxes, inheritance taxes etc., which need to be paid by heirs/beneficiaries of a descendant in accordance with rules, framed therefor.

In estate planning, one must also be aware that it is legally permissible to 'gift' property or cash up to $12000 in a calendar year to one person without attracting any gift tax. In a lifetime, such $12000 gifts can total up to $1million without attracting any gift tax. A gift over $12000 is taxable for the amount in excess of $12000 but no gift tax need be paid at once although a gift tax return does need to be filed. The tax due on the excess amount can be successively added every year and finally be set off against the estate tax exemption limit as a tax benefit known as a 'unified credit'. In one way, gift and estate tax are tied together.

Simply stated, if the sum of the amounts of the taxable estate and the total of gifts in excess of $12000 over the years comes up to the federal estate tax exemption limit of $2million, no gift tax or estate tax is payable.

Apart from this, you can reduce the size of your taxable estate by paying for anyone's tuition by directly paying the educational institution. Medical expenses that are not covered under insurance can also be paid without attracting any tax. Forming trusts has already been mentioned above and includes life insurance trusts, charitable trusts, living trusts, revocable trusts, personal resident trusts, credit maximizing trusts etc.