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What You Should Know About Estate Taxes

Part of careful estate planning includes learning everything you can about estate taxes. If you don't, your beneficiaries may end up receiving a lot less than you intended. For fast, easy and affordable help in setting up your living trust go to www.legalzoom.com.

Estate planning is imperative to keeping the government's hands away from the bulk of your hard-earned assets

Many estates will fall beneath the federal exemption limit. If yours does, you do not have to pay estate taxes. You might breathe a sigh of relief and assume that you could never be worth over two million dollars, but you might be surprised. The federal government includes many more things than houses in your estate, life insurance policies, for instance. Sometimes, people who think they could never wind up over the limit, do. So it is wise to add up your assets, even if you don't think you need to, preferably with the help of an expert estate planner.

The federal estate tax rate

Estate tax rates are some of the highest around, starting at 37 percent and climbing as high as 47 percent. You can see why careful estate planning is imperative to keeping the government's hands away from the bulk of your hard-earned assets.

The unlimited marital deduction

If you wish, you can pass your estate to your spouse and not pay any estate taxes, even if you do exceed the federal exemption limit. This is called the "unlimited marital deduction." The only thing to remember is that your spouse's estate increases exponentially in this case because your estate is now melded into his or hers. When your spouse dies, the estate taxes could be that much higher. There are, however, ways around this issue.

Cutting your federal estate taxes

With a charitable trust, you can make a gift to a tax-exempt charity.

You could set up an AB trust. In this scenario, the couple leaves the property in trust for their children, but the surviving spouse has access to it for the remainder of his or her life. This, in convoluted tax form, makes the surviving spouse's estate half of what it would be if the estate had been left solely and completely to him or her.

Making tax-free gifts can lessen your estate. You are allowed to give up to $12,000 each calendar year to someone like a child, for instance, or a parent. Another method is to pay a grandchild's college tuition or an elderly parent's medical bills. Anything under $12,000 is exempt from the federal gift tax. When you give money to those you care about, you shrink your total estate. You can do this each and every calendar year.

If you put your life insurance policy in a trust, it will be taken from out of your final estate.

About the AB trust

First, remember that trusts avoid probate whereas wills do not. Additionally, the details of a trust remain private forever, while the contents of a will become public.

The AB trust, also known as a "Marital Bypass Trust," "Credit Shelter Trust," "Exemption Trust" and "Marital Life Estate Trust," is designed to save lots of money in taxes while providing for the surviving spouse. Additionally, when the surviving spouse passes away, the AB trust will then be distributed to the final beneficiaries (usually the children.) The AB trust is best utilized when a couple is older, because once an AB trust is established, it cannot be changed. There are other tax-saving methods younger couples can use, such as a living trust, which can be changed. When you as a couple get older, you can revoke the living trust and create an AB trust if you wish.

When the time is right, a couple sets up an AB trust and leaves all of the property from each person to it. Then, when one spouse dies, the surviving spouse can use that property, but he or she does not actually own the property anymore, and there are certain restrictions on what he or she can do with it. The tax break comes into play because the property never legally belongs to the surviving spouse.

While the surviving spouse lives, he or she can use the income to pay medical bills and other kinds of support needs. He or she can continue to live in the couple's home, even though it now really belongs to the trust. When the remaining spouse dies, the property in the AB trust passes to the final beneficiaries, which were named when the trust was created.

Something to remember about an AB trust is that it is "irrevocable," which means it cannot be changed once it is set up. It's important to go over all the benefits and drawbacks of an AB trust before establishing one so that you understand fully what will happen.

Problems and solutions concerning life insurance

We all know that the beneficiary of a life insurance policy is exempt from paying income tax on the proceeds. Yet something that is rarely mentioned is that the life insurance policy you purchased when your child was small will be counted as part of your taxable estate when you die. If you are the insured person and the owner of the policy, you fall into this category. If the beneficiary is your spouse or a charity, the federal estate tax does not apply because of the previously-mentioned "marital deduction."

To protect your life insurance policy from becoming a taxable part of your final estate, you may wish to:
  • Transfer ownership of the policy into a special trust, which must meet certain requirements.
    • The trust must be irrevocable
    • You must establish this trust at least three years before you die; otherwise, the proceeds will be counted as part of your final estate. However, if you establish a new life insurance policy making someone else the owner, or if you set up a new policy to be owned by a trust and it is never in your name to begin with, then the three-year rule does not apply.
  • OR
  • make your children the owners as well as the beneficiaries.
    • When the bill is sent to them, you can provide them the premium payments. Just be sure that the money you send does not exceed the $12,000 gift limit, so you don't end up paying a tax on it.

State estate taxes

Because the federal estate tax has been steadily diminishing, states who used to get a cut of that federal money are now figuring out other ways to recoup their losses. One way is through "State Estate Taxes." You might find that the exemption for state estate taxes is quite a bit lower than the federal level. For instance, New Jersey and Rhode Island begin charging estate or inheritance tax if a person's estate is valued at over $675,000. Some states have no estate tax at all, and in some states, the exemption matches the federal numbers. Where does your state fall? An expert estate planner can tell you. If you are retiring and thinking about moving to a cheaper state, perhaps one that has no sales tax, don't forget to find out what the estate and inheritance taxes are before you make your final decision. Even if that state has no sales tax or income tax, you could find the estate taxes overwhelming.

Joint tenancy

Joint tenancy is a method for two people (or more) to share ownership of property. In this case, when one party dies, the other becomes owner of the deceased person's share. Husbands and wives often use this method to lessen the tax bite. Joint tenancy takes precedence over any wills.

Because of the way joint tenancy is structured, you don't need a will to make certain the right people get your property. It automatically goes to the surviving joint tenant and avoids probate.

Joint tenancy is a great idea. However, it is important to remember that each individual in a marriage is entitled to the federal estate tax exemption. So, if you and your spouse hold all your property in joint tenancy and one of you dies, you will miss out on taking advantage of that individual's exemption.

Living trusts

The AB trust is more complicated than simple living trusts. If you don't want the expense and complications of an AB trust, establish a living trust during your lifetime. You will still save a bundle in time and money, because the property in the trust does not have to go through probate, although it's important to remember that simple living trusts are subject to estate taxes. Living trusts can be revised or cancelled, and if you use one in conjunction with a "Pour-Over Will," even property you forgot to put into the trust will automatically be transferred at the time of your death into the trust.

Hopefully this information will steer you toward getting the help of a competent estate attorney when you are ready to delve into your own estate plan. This article is meant to offer insight into the world of estate taxes, but is a general overview only and merely scratches the surface of very complex issues. A qualified estate planning expert will be able to guide you every step of the way and make certain everything is written to your best advantage.

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