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How to Protect Your Heirs from the Estate Tax as Bush Tax Cuts Expire

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You don’t need a fortune cookie to figure this one out. Start planning now to take care of your heirs.

If you’re one of the lucky Americans to have an estate worth more than $1 million, you likely have fewer worries about a secure retirement than others.

However, trying to pass your wealth along to your children or other heirs without the federal government grabbing a slice has become especially complicated.

Over the past few years, the U.S. Congress has refused to put in place a consistent policy on exemptions and tax rates for the estate tax, known in some circles as “the death tax.”

But despite the uncertainty, there are ways you can plan ahead to ensure your estate goes to your heirs and not to the government.

Note: If your estate is worth less than $1 million you needn’t be concerned about the estate tax, at least for the time being, but that doesn’t mean you don’t need an estate plan. Check out “Why Americans without Taxable Estates Need an Estate Plan” for more information.

Keeping track of how much is protected

The amount of your estate that you can shield from inheritance taxes grew from $675,000 in 2001 to $3.5 million in 2009 before the estate tax disappeared completely in 2010. Beginning in 2011, the tax reappeared with a $5 million exemption, which rose slightly to $5.12 million in 2012.

With the Bush tax cuts expiring on Jan. 1, 2013, the estate tax exemption returns to $1 million, the same level as 2002 and 2003, unless Congress and the President agree to change it.

At the same time, the tax on estates will return to 55 percent of the amount subject to the tax, the same rate as 2001, after falling to 35 percent in 2011 and 2012.

If your estate is over 1 million, it’s a good idea to talk to your attorney now about how to plan ahead. You can’t control what Congress and the President will do, but you can set up legal precautions so you’re ready for whatever happens.

How an A/B Trust Can Help

One approach to consider if you’re married and have an estate worth more than $2 million is to set up an A/B Living Trust for your children or other heirs through an attorney. This trust enables you to exclude the entire exempted amount at the time of the death of the first spouse, placing it into an irrevocable “B trust.”

All the assets in the B trust, no matter how much they have appreciated in value, will be transferred to the heirs, estate-tax free, at the time of the death of the second spouse.

When the second spouse dies, the heirs will receive the entire eligible exemption in that year for the assets in a second, revocable “A trust.” Without an A/B Trust, the entire estate will receive only the one exemption in place in the year the second spouse dies.

But the reversion to the $1 million exemption on Jan. 1 has created a potential problem for people with estates that will now be exposed to the tax once again, over and above what’s protected in their A/B Trusts.

For example, if the second spouse dies in 2013, the A trust will only have a $1 million tax exemption, compared with the $5.12 million exemption it would have had if the second spouse died in 2012.

How a Dynasty Trust Provides Even More Estate Tax Protection

If your estate is worth more than $2 million, your heirs could be in a better position in the future if you also have a Dynasty Trust, in addition to your A/B Trust.  The Dynasty Trust allows you to place up to $5.12 million this year in a trust that will be passed on free of estate taxes regardless of what the exemption is in the year that either spouse dies.

Your heirs will be the trustees of the Dynasty Trust and will invest the assets and receive the income from it.

Keep in mind that one potential downside of the Dynasty Trust is that it is irrevocable, meaning that the assets will belong to your heirs and you cannot take them back once you place them in the trust.

Plan Ahead Now Because of Estate Tax Uncertainty

Although the House of Representatives has voted to retain the $5.12 million estate tax exemption, the $1 million exemption for 2013 remains part of current law, which can only be changed with the consent of both houses of Congress and the President.

Any changes to the 2013 exemption will likely depend on the outcome of the November election and subsequent negotiations over a new comprehensive tax package.

With Congress facing key decisions on taxes after the election, it’s a good idea to talk to an estate planning attorney now about strategies available to protect your heirs.

You’ll have many considerations when setting up or making changes to your estate plan. It’s best to speak to a lawyer so you can get the best advice for your specific situation. Now’s the time to plan ahead so you’ll be prepared—come what may in 2013.

About Rick Radin

Rick Radin has been a reporter, editor and copy editor at Web sites and newspapers in the San Francisco Bay Area for two decades. He has worked at the San Francisco Chronicle, the Contra Costa Times and as News Editor for the Daily Journal, the San Francisco-based legal newspaper. Rick has a B.A. in English from UC Berkeley and an M.A. in English from Stanford University.
Posted in: Home & Family, Wills & Estate Planning

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