A SPLIT DECISION… YOU AND THE IRS

 

This is not a catchy story, just a practical tax-related one that most people do not yet know about.

Less than two weeks ago we finally got forms to report estates for people dying in 2010… THEN THEY CHANGED THE LAW!

On December 17 the estate exemption was reinstated effective January 1, 2010. The federal estate tax exemption was set at $5 million per person. This will be federal law for two years. Estates can choose to remain under the old 2010 law, but that is not advisable for most estates (run the numbers and compare!) The Washington State exemption remains at $2 million per person; I have idea if or when that will change.

When a spouse dies, if the Will or Trust contains tax planning, there is an opportunity to claim two estate tax exemptions. In other words, married people, through a "trust split" written into their Will or Living Trust, can effectively use two exemptions and keep all assets available for the surviving spouse. The complicating factor is that the federal and state exemptions are NOT the same number in Washington State.

Let me illustrate with two examples. THIS IS NOT LEGAL OR TAX ADVICE – CONSULT YOUR OWN LEGAL OR TAX COUNSEL USING YOUR FACTS!

Let's say we have a combined Washington estate (both spouses added together) of $2.2 million. The estate plan says give all to survivor unless he/she disclaims. Survivor's share of estate is kept in his or her name or Survivor Trust share; disclaimed amounts are allocated to a separate Shelter Trust that uses the decedent's exemption…

There are two basic choices:

I. Survivor keeps all. Here, when survivor dies, under current law $200,000 might be subject to Washington State inheritance tax. Estimated TAX IS $20,000.

OR

II. Survivor disclaims $200,000 or more to reduce taxable future estate to $2 million. Survivor could disclaim the fully allowable $1.1 million (½ of the community property).

a) Survivor must establish a trust share to own those disclaimed assets. This is a small hassle.

b) Survivor will also have to annually file an IRS Form 1041 to report income tax on the Shelter Trust.

c) Under current estate tax law, no tax at death of Survivor. WOULD SAVE $20,000 Washington Inheritance Tax. Is the hassle worth it to you?

d) You could gift assets or spend them on yourself instead.

 

NOW, what if the combined estate is $5 million?

SAME PLAN DESIGN; but if Survivor keeps all when survivor dies, under current law $3,000,000 would be subject to Washington State inheritance tax when he or she dies. Estimated TAX IS $390,000.

OR

Survivor disclaims $2,000,000 to fully fund the Shelter trust without triggering a tax now. This is LESS than ½, but completely uses the State and most of the Federal exemptions.

1) Survivor must establish a trust share to own those disclaimed assets. This is a small hassle.

2) Survivor will also have to annually file an IRS Form 1041 to report income tax on the Shelter Trust.

3) Under current estate tax law, no tax at death of Survivor.

4) Is it worth it to you? SURE LOOKS LIKE IT TO ME. Split!

Use current state exemption of $2mm for that amount to go to Shelter Trust to avoid triggering a state tax now and both state and federal later. (Note that you COULD overfund and pay only state inheritance tax of $50,000 to hopefully avoid a combined state and federal tax later.)

If you suffered the loss of a spouse in 2010, I want to offer my sincere condolences. Keep in mind that your loved one did this planning to benefit you and future heirs too. It was a thoughtful and unselfish act and another nice memory of someone who thought of others.