The following section offers some recent developments in estate planning which
may be interest to you. Please read our disclaimer under our Frequently Asked Questions section, and as always,
it is important to seek individual advice relevant to your own circumstances,
as this is intended to be a broad overview, and not an exhaustive or definitive
New Tax Law
As you may know, President Bush recently signed into law one of the most
important tax bills to be enacted during the last two decades, known as the
Economic Growth and Tax Relief Reconsideration Act of 2001. It makes
approximately 440 changes related to income taxes, estate and gift taxes,
retirement plans, and other tax areas.
The new law makes substantial changes to the estate and gift tax. It should
significantly reduce the amount of estate taxes paid over the next eight years and
repeals estate taxes (but not gift taxes) in the year 2010. However, although
the new law results in reduction of estate taxes, it does not do so simply.
It changes the estate tax exemption, the top estate tax rate, and other factors
through a number of staggered changes each year.
The estate tax exemption is the amount each individual can transfer at death
free from estate taxes, while the gift tax exemption is the similar limit for
gifts. For many years, these two exemptions have been "unified";
however, starting in 2004, they will diverge with the estate tax exemption,
exceeding the gift tax exemption.
The generation skipping transfer tax exemption is the amount you can leave in
trust for, or give directly to, grandchildren or more remote descendants
without incurring an additional tax. For many clients, it is the amount used
to establish "generation skipping trusts" for children which will not
be taxed, even under the current estate tax system, when the children die.
This amount was always a separate amount, $1,000,000 indexed for inflation
each year. Starting in 2004, it will be the same amount as the estate tax exemption.
Estate and Gift Tax Chart
The following chart details the applicable changes provided for in the bill.
Due to the "sunset" provision discussed below, year 2011 and 2012
amounts reflect the amounts in effect prior to this new tax law, since the new
law automatically cancels itself in 2011.
||Estate Tax Exemption
||Gift Tax Exemption
||Top Estate Tax Rate
||Generation Skipping Tax Exemption
||55% (60% with surtax)
||Based on inflation
||Based on inflation
||0% (Gift Tax 35%)
||55% (60% with surtax)
||Based on inflation
||55% (60% with surtax)
||Based on inflation
Examples Calculating Tax
To give an illustration of these changes, let's examine the tax effects on
individuals with varying sized estates dying in different years in a very
For the first example, let's imagine an individual with an estate (after
expenses, deductions, etc.) of $850,000, and assume that expenditures and
growth are such that this amount remains constant. If that individual died in
2001, the tax on his estate would be $66,750. If that individual died next year,
there would be no estate tax, and under the current law, the same would be true
for all years thereafter.
For a second example, let's use an individual with an estate of $1,500,000.
If that individual died in 2001, the estate tax would be $335,250. If she
instead died in 2002, the estate tax would be only $210,000. In 2006 it
would be nothing, and the same in 2010. However, if she died in 2011, under
the automatic sunset provision, if that is not changed, she would owe tax in
the amount of $210,000.
For a third example, let's use an individual with an estate of $4,000,000.
If he died in 2001, the estate tax would be $1,620,250. In 2002 it would be
$1,430,000. In 2006 the estate tax would be $920,000. In 2010, it would be
reduced to nothing, under the complete repeal, but by 2011, the automatic
"sunset" would mean the estate tax would be back to $1,495,000 if
the individual died in that year.
The following shows these results in a chart form:
Carry Over Basis
For the year 2010, there is also a significant change in capital gain
determination. Decedent's heirs will no longer receive a "step-up"
or "step-down" to fair market value of their cost basis, which
determines capital gains when assets are sold. There are some exceptions,
but the default rule will be that assets received from a decedent will keep
the decedent's cost basis. This results in increased capital gains and
requires much more complex record keeping to determine what an heir's basis is
in inherited property. This new system is referred to as "carryover" basis.
Sunset Provision (Automatic Un-Repeal!)
As cited in the May 30, 2001 issue of The Wall Street Journal, the chances
of these changes surviving until 2010 must be balanced against the fact that
in the past five years, there have been 1,916 changes to the federal tax code, and
since 1986, there have been about 7,000 changes.
The new law contains a "sunset" provision which repeals this new
legislation as of 2011. Therefore, estate tax repeal, and the increases in
exemption amounts and reduction in tax rates, will need to be affirmatively
reenacted to be in effect after 2010. It is possible that the government would,
in the future, remove the sunset provision, but it is of course impossible to
accurately predict such future action.
Effect on States
It is also important to note that the new law very rapidly reduces
the portion of estate taxes which generally pass to the states. Currently,
federal estate tax law allows a certain amount paid to states to be credited
against the federal tax due. Many states, including Arizona, have an estate
tax which simply is this maximum credit. This does not effect the total estate
taxes paid, it merely reallocates it between federal and state governments.
However, the new tax law, over three years, reduces this credit to nothing,
so states would then be receiving nothing of the estate tax if they maintain the
tax based solely on the credit. While this will not directly effect taxpayers,
because it will reduce revenue so greatly for the states, it is anticipated that
states could initiate their own separate tax which would increase total taxes
paid at death.
Questions and Answers on New Law
In light of the new tax law, we thought it would be helpful to answer some
Are there any immediate changes I need to make in my estate plan
to address the new law?
It will generally not be necessary to make any immediate changes in your
existing estate plan to address or take advantage of the new tax law. As noted
above, the changes in the next two years are relatively minor compared to what
happens by 2010. However, this does provide an excellent opportunity for you
to review your existing estate plan, not only for estate tax issues, but to
ensure all other aspects are still in accordance with your wishes.
Also, due to the carryover basis provisions, you should ensure you are
keeping accurate information as to the cost basis of your property, and work
closely with your broker, financial planner, or accountant on those issues.
What changes in my estate plan should I consider for the long term?
It is important to consider how the above changes may affect your personal estate
plan. Generally, plans and documents which provide for allocation based on the
estate tax exemption are drafted to automatically take into account these types
of changes. For example, many husbands and wives have documents which create a
Family Trust or Credit Shelter Trust which is designed to hold the estate tax
exemption amount upon the first spouse's death. The allocation clauses usually
automatically shelter any increased exemption amount. This automatic allocation
is usually advisable, since it avoids the needs of redrafting documents to take
into account changes each year.
However, some clients utilize that type of allocation to divide assets between
different beneficiaries, such as a spouse and children of a prior marriage, or
between a charity and individual beneficiaries. For instance, a document may
provide that the estate tax exemption amount passes to individual
beneficiaries, and the balance goes to a charity. A client planning that
arrangement for a $600,000 estate tax exemption must realize that if he or she
died in the year 2006, this would instead mean up to $2,000,000 passes to the
individual beneficiaries. This could drastically change the disposition of
assets from what the client intended, and even disinherit some intended
beneficiaries. It is therefore advisable to consider your own individual plan
to determine if you might be affected this way, and to contact us with any
questions you might have.
Some married clients who determine at a future date that their combined assets
will be under the applicable estate tax exemption may reconsider whether it is
necessary or advisable to automatically establish a Family Trust or Credit
Shelter Trust upon the first spouse's death. Consideration might be given to
eliminating that split, or at least altering it, so such a division is not
required for the survivor.
Additionally, as time passes and we get closer to the carryover basis system,
planning based on your existing assets will become very important.
Is a Trust still necessary for my estate plan?
A Trust still remains a valuable estate planning tool for most clients. The
changes in the tax law do not change in any way the non-tax advantages for
establishing a Revocable Trust, which include avoiding probate if assets are
properly funded into the trust, providing a secure and efficient means of
managing assets in the event of incapacity, keeping disposition of your assets
from public record, and protecting assets for beneficiaries.
As noted below, the ability to limit creditor's claims under new Arizona law
makes the Revocable Trust an even more attractive option.
While estate taxes should be greatly reduced by the new law, even the Credit
Shelter/Family Trust division should still remain an important and valid estate
tax reduction tool for many married couples in light of the graduality and
uncertainty of the new law.
Do I still need to worry about estate taxes?
While the new law reduces the amount of estate taxes which should be payable, for
at least the next eight years we will still have estate taxes, and it is
important to plan to minimize these taxes in accordance with your wishes.
Given the uncertainty of the new law, and indeed, the automatic cancellation of
the repeal by 2011, it is likely that estate taxes may still be with us
following 2010. Planning for estate taxes will be more complex, as changes in
the law and uncertainties require addressing more contingencies and possibilities.
For all these reasons, estate tax planning is still important for many clients.
New Options for Probate Avoidance Under Arizona Law
Many clients wish to avoid probate (see our Frequently Asked
Questions section for more details on what probate entails) to reduce legal
fees and court costs, but for some clients, their assets may not be enough to
justify a Revocable Trust, which is generally the most effective means of
avoiding probate. Putting property into joint tenancy with right of
survivorship can accomplish this, but this is generally not recommended
(except for married couples) because the creditors of the intended beneficiary
may be able to reach accounts during the client's lifetime. Many banks and
brokerage companies offer a "P.O.D." (payable on death) designation
which is more appropriate, since it only becomes effective when the client dies.
However, for clients with a home or other real property, there was no similar
However, the Arizona legislature has passed a law which will become effective on
August 9, 2001, allowing an individual to create a "Beneficiary Deed"
which will be similar to a P.O.D. account, and have no effect until death, but
at that time automatically transfer property. This could allow certain
individuals to effectively avoid probate without endangering their assets or
establishing a trust.
It should be cautioned that use of these type of techniques must be used
quite cautiously, and in many situations, a Revocable Trust or a Will and
accompanying probate is much more appropriate, especially in more complex
division schemes. However, in certain circumstances they may be of great
benefit. As always, you should seek individual advise as to the risks and
rewards of this type of arrangement. Once this new Deed becomes effective,
we will be able to prepare those for clients in appropriate situations.
Limiting Creditors' Claims Against Revocable Trusts
One advantage to a probate proceeding (see our Frequently Asked
Questions section for more details on what probate entails) after an
individual dies is that it offers a certain level of protection from creditors.
Namely, once a probate is established, and notice is mailed to known creditors
and published for unknown creditors, all creditors have only four months to make
a claim on the estate, and if they do not, their claims are usually null and
void. This is a much shorter period then the typical statutes of limitation,
which generally run from two to six years.
Therefore, in some situations it has been advantageous to have a probate
proceeding, even when unnecessary, to protect against later liability.
This could be somewhat counterproductive when individuals had established a
Revocable Trust, but deemed necessary in certain cases of potential liability.
However, the Arizona legislature has recently passed a new law which will allow
the Trustee of a Revocable Trust, without filing anything in probate court,
to mail notice to known creditors and publish notice to unknown creditors, and
achieve the same four month limitations for claims against the estate. This
becomes effective on August 9, 2001.
Income and Principal Act
Arizona's legislature has recently passed a new "Uniform Principal and
Income Act" which will become effective on December 31, 2001. This law
governs exactly how a Trustee is to account between principal and income. The
purpose is of course to determine how much money is received by an individual
who is entitled to all the income from a trust. Although a fairly technical
act, this new law makes allocation of these elements much more flexible.
Individuals who are entitled to income from current trusts may find that the
amount they receive may increase or decrease, based on these changes and how a
Trustee implements them.