Is Your 1990’s Tax Planning Will Going To Cost Your Spouse Thousands?
Many tax planning wills and trusts have a little secret hidden deep down inside – the up front expense of long-term estate tax planning. There is a cost to a will or revocable trust that creates irrevocable, tax planning trusts at death. A person should always review that plan and ask himself or herself, is the benefit worth the cost?
The cost is a dollar cost in implementing the tax-planning trust. To understand the problem requires understanding a little about federal estate taxes.
Understanding the Federal Estate Tax
The federal estate tax is a tax a person pays upon their death for the “privilege” of transferring their property to their heirs or devisees. In 2007, the first 2 million dollars is exempt from federal estate tax. Anything over 2 million dollars is taxed at roughly 40% unless given to a spouse who is a U.S. citizen.
The Importance of a Tax Planning Trust to Maximize Wealth Passed to Heirs
In order to maximize the wealth passed to heirs, a husband and wife can double up on their exemptions by creating a tax planning trust to hold up to 2 million dollars of the first spouse to die. When the surviving spouse dies, the 2 million dollars in the trust is passed along to the heirs along with the surviving spouse’s estate. If the surviving spouse’s estate is under 2 million dollars, no estate tax is owed. The net savings in a combined estate worth 4 million dollars is roughly 1.5 million dollars.
Sounds great, right? So, what is the catch? The catch is that there will be substantial legal and accounting expenses incurred in setting up that tax-planning trust. To save 1.5 million dollars in estate taxes in the future may cost ten to thirty thousand dollars, today.
How a Tax Planning Trust Can Fail
In our example 1.5 million dollars was ultimately saved for the heirs. This does help take the edge off the up front expense. However, what if the combined estate of both husband and wife is under 2 million dollars? If the only purpose of the tax-planning trust is to avoid estate taxes, the plan failed. The plan failed because the surviving spouse has a 2 million dollar exemption from estate tax of his or her own. He or she does not need to “double up” on the exemption. Now comes the part most married couples do not seem to understand.
When a person dies, the terms of their estate planning documents come into play. If the documents call for the creation of irrevocable trusts (i.e., the tax-planning trust), the trusts must be created. If the trusts are not created, in most cases, somebody has breached a fiduciary duty and can be in deep trouble.
Periodically Update Your Tax Planning Trust
The issue with older estate plans is that the estate tax exemption used to be much lower than the current 2 million dollars. When those estate plans were executed, they made good sense. Today, those same plans may need to be reviewed and perhaps changed.
There are many excellent, non-tax reasons to create an irrevocable trust when a spouse dies. A married couple should periodically review whether their combined estate is subject to estate tax. If the combined estate is below the current estate tax exemption, then the couple should review the non-tax reasons to create a trust. If the benefits do not outweigh the dollar cost, the plan should be changed, today. Otherwise, the surviving spouse may pay substantial legal and accounting expenses without receiving any benefit.