Tag Archives | Estate Planning

The estate tax is gone, but don’t celebrate yet

We are seven weeks into the new year and there is still no clear roadmap for the estate tax.  It’s probably not too early to think about what might happen in 2011 — a 55% estate tax with a $1 million exemption.

But what about 2010?  Should we all be celebrating the (at least temporary) demise of the estate tax?

Not so fast…

The estate tax hasn’t been removed, it has been replaced with another tax.  The new tax is the capital gains tax.

Thousands of estates will be impacted.  In fact, the chief tax counsel for the House Ways and Means Committee (the committee responsible for writing tax bills) estimates that an additional 65,400 estates will have to pay taxes in 2010 because of the elimination of the estate tax.

If that doesn’t make any sense, then let me explain the concepts of “basis” and “step up” and how they were affected by the change in laws on January 1.

If you buy an asset (for example: a house, shares of stock) and sell it later for a profit, you have to pay capital gains taxes on the profit.  The price that you paid for the asset is called the basis.

Sometimes the basis changes.  For someone dying last year, the basis of each of their assets would change (step up) to the value of the asset on the day that person passed away.

An example might make that more clear:

Appreciated Assets in 2009 (With An Estate Tax)

  • Steve buys 100 shares of Apple, Inc. stock for $5 in 1997.  His basis for each share is $5 (the total basis is $500).
  • Steve passes away in 2008.  At the time, the shares of Apple stock are valued at $100.
  • Steve’s trust leaves the shares to his daughter Kate.  Kate’s basis in the shares steps up (changes) to their value at Steve’s death — $100 (for a total basis of $10,000).
  • Kate sells the shares in 2010 for $200 each.
  • Kate has to pay capital gains taxes on a $10,000 gain (100 shares times the difference between the sale price of $200 and the basis of $100).

Here’s how that would have looked had Steve passed away under the laws as they currently stand for 2010:

Appreciated Assets in 2010 (With No Estate Tax)

  • Steve buys 100 shares of Apple, Inc. stock for $5 in 1997.  His basis for each share is $5 (the total basis is $500).
  • Steve passes away in 2010.  At the time, the shares of Apple stock are valued at $100.
  • Steve’s trust leaves the shares to his daughter Kate.  Kate’s basis in the shares does not change, but remains at $5 (for a total basis of $500).
  • Kate sells the shares in 2010 for $200 each.
  • Kate has to pay capital gains taxes on a $19,500 gain (100 shares times the difference between the sale price of $200 and the basis of $5).

Under the old estate tax system, a person could pass on assets worth $3.5 million (and for which the basis would be $3.5 million) without paying any federal taxes. Now, much smaller estates are exposed to taxes.

Congress hasn’t left us completely out in the cold, though.  In 2010 you can increase the basis of property you pass on by up to $1.3 million.  Again, let’s take a look at an example:

Using Your IRC § 1022 Basis Increase

  • An entrepreneur, Julie, starts a business with just $100,000 in seed money.
  • Julie’s business has grown to be worth $3 million when Julie passes away.
  • Julie trust leaves her business to her son, Mark.
  • Mark’s basis in the business, if he chooses to later sell his shares, can be increased to $1.4 million.  This would use the entire $1.3 million increase available to Julie.

The situation is even worse for couples.  Under the 2009 estate tax laws, all property left by the decedent to their spouse would get the setup up in basis.  Someone passing away in 2010 can only increase the basis of property left to a spouse by up to $3 million (in addition to the general basis increase of $1.3 million).

So who is at risk of additional taxes now that the estate tax is gone?  Many people could be swept up into these new taxes.  But two groups in particular should carefully consider their planning in light of the changes in the law in 2010:

  • Married couples or individuals with substantially appreciated assets or a closely-held business
  • Anyone with a net worth between about $1.5 million and $3.5 million that includes appreciated assets

If that sounds like you and your family — you’re not alone.  We could see a 1000% increase in the number of estates that owe taxes this year.  And then it’s all supposed to reset in 2011, with an estate tax at the antiquated limit of $1 million.

So this story is almost certainly not over.  Stay tuned!

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Is your estate worth $800,000?

How much is your estate worth to you? I don’t mean how big it would be. I mean, how much is it worth to you to have your estate handled the way you want it to be?

On Friday, we learned that Bartley King’s estate was worth $800,000.

Bartley King died on July 5, 2004. He left behind a son, two daughters, and fifteen grandchildren. Four years before Bartley died, he had executed a new will. This new will named his daughter Folan as the executor and primary beneficiary.

Bartley’s son (Robert), his other daughter (Helen), and nine of his grandchildren filed a lawsuit complaining that the new will and other estate planning steps Bartley took in 2000 were invalid. Their central arguments were that Bartley lacked the mental capacity to change his will and that Folan had taken advantage of Bartley and convinced him to change his will in her favor.

The trial was held in January 2007, and Folan won. The trial judge found no credible evidence that Bartley lacked the capacity to change his estate plan. From the victory, Folan became entitled to receive Bartley’s $1.2 million estate.

But first she had to pay her lawyers.

Folan hadn’t hired just any lawyers. She had hired K&L Gates, a mega law firm with 35 offices and 1800 lawyers scattered around the globe.

A law firm like K&L Gates doesn’t come cheap. Despite the case being rather straightforward (the trial judge said it wasn’t “overly complex”), K&L Gates had a total of 18 attorneys and paralegals on the case.

The final tab for those 18 expensive professionals? $710,321.50

Throw in another $95,868.47 in costs (things like copies, legal research, and travel), and the total came to $806,189.97.

Folan spent over two-thirds of her father’s estate defending a lawsuit from her siblings, nieces, and nephews (and perhaps even her own children — that’s not clear from what I have read).

Of course, that’s not the end of the story. The trial judge originally awarded Folan $574,321.50 in attorneys fees and costs — to be paid by her brother, sister, and other relatives who had sued! This past Friday, the Massachusetts Supreme Judicial Court overturned the award and asked the trial court to reconsider.

So where is all this leading?

It’s anyone’s guess how the fees will shake out. But it doesn’t really matter what the final bill is for Folan or how much her relatives have to pay.

The tragedy has already happened. All they’re doing now is sorting out how much it will cost and who is going to pay for it.

Anyone who is thinking of treating some children or family members differently than others may be faced with the same difficulties.

There’s no right or wrong way to handle the situation. Any solution is going to be based on family history, personalities, and some judgment calls.

But there is one step you can take that will almost certainly help, creating a living trust.

In Illinois, your spouse and children must generally be given a copy of your will — even if they aren’t named as beneficiaries or are specifically disinherited. And the entire process of executing the will is played out in open court, for everyone to see.

How much you had (or didn’t have). Who got what. Anyone can go find those things out.

A trust, on the other hand, is private. You aren’t required to provide a copy of your trust to your children or anyone else who might be interested in your estate plan. No one will know anything about how your trust works except your trustee and your beneficiaries.

It’s just another one of the advantages of using a living trust over using only a will — the ability to plan your estate in privacy, and hopefully in a way that won’t ruffle anyone’s feathers.

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The power of attorney (not just) for property

With the rise of revocable living trusts for estate planning, the durable power of attorney has often been pushed into the background. But is is still a very important tool, even if most or all of your property is owned by a trust.

The ability to name an agent through a power of attorney is very flexible. You can give as few or as many powers to your agent as you wish. These are some of the more useful things an agent can do for you:

  1. Apply for public benefits for you. Your agent can file on your behalf to receive SSI or Medicaid benefits. Medicaid is an important way that many people use to pay for their nursing home care — something I will be discussing more in the coming weeks.
  2. Manage property not owned by your living trust. Unless an irrevocable life insurance trust is used, people often own life insurance in their own name. Your agent can also manage your IRA accounts, 401(k) accounts, or company pension account that an incapacity trustee would not be able to help with.
  3. Sign contracts on your behalf. Your agent can sign contracts for you, such as nursing home admission papers.
  4. Hire an attorney. An agent can hire an attorney to represent you in a variety of matters — medicaid planning, filing a lawsuit, filing for bankruptcy.
  5. Make gifts for planning purposes. You can authorize your agent to make gifts on your behalf for tax planning or Medicaid planning purposes.
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