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2008 Tax Planning Guide:
Plan strategies now that may reduce your personal and
business taxes next year. The sooner you start, the sooner
you get there...
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For anyone with a net worth exceeding $1,000,000, planning how to pass along
your wealth is a balancing act. You must find a comfortable point somewhere
between the desire to provide for the people and causes you cherish, and the
federal and state estate taxes that can claim as much as two-thirds of your
assets. At The Commerce Trust Company, we have provided guidance on how to
achieve this critical, and highly personal, point of equilibrium for decades.
So we understand that, the greater your wealth, the more challenging this
process can be.
Working with your attorney and tax advisor, we can help you devise a
combination of wills, trusts and other wealth-transfer techniques that minimize
the challenge. Like your key financial advisors, our Estate and Tax Planning
Advisory consultants have in-depth knowledge of the tax laws that can erode
your estate, both before and after death.
On a daily basis, we advise affluent individuals and families in the use of the
most common tools for keeping an estate intact—such as the annual gift-tax
exclusion, unified credit and unlimited marital deduction. We also introduce
them to topics, tools and techniques that are especially important for the
affluent, including:
ESTATE PLANNING
When it comes to estate planning, there are two kinds of people: those who have
done it and those who wish they had. "Estate planning is something everyone
needs to do," says Ray Stranghoener, President of The Commerce Trust Company.
There are four issues to consider:
1. Family
Making sure the surviving spouse and dependents are provided for is a concern
of most married couples. In blended families, the issues can grow more complex,
given the needs of spouses, ex-spouses, children and stepchildren.
Most common family issues can be addressed through the creation of a trust. A
trust is typically administered by a trust company, with the trustee charged
with making decisions about allocations.
2. Investments
"Whether married or single, most people underestimate their net worth," says
Stranghoener. "People may overlook life insurance policies, retirement benefits
and other 'hidden' assets as sources of future income.
3. Health Issues
There are three documents you can prepare now to help ensure your wishes are
carried out: a living will, healthcare power of attorney and durable power of
attorney.
Also, consider creating a family medical history. Knowing what illnesses run in
your family will help you make better decisions on whether to take out more
comprehensive medical or long-term care insurance policies.
4. Taxes
There are many things a person can do to minimize his or her heirs' tax
burden," says Stranghoener. "Such as placing the money in a trust or beginning
a gift-giving program."
The five documents every adult should have:
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A will—to dictate what happens to your assets when you die.
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A revocable trust—to help prevent your estate from going through a process that
can result in the unnecessary payment of large fees.
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A durable power of attorney—to give the person of your choice the right to
continue business on your behalf.
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A living will—to dictate your wishes in the event of a terminal injury or
illness.
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A healthcare power of attorney—to give a chosen person the right to act on your
behalf and authorize care in the case of a non-terminal accident or sickness.
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NEW ESTATE TAX RULES
Congress recently passed new regulations that heralded the elimination of estate
taxes. Unfortunately, this had more political and media hype than substance.
Under the former rules, the "unified credit" allowed a person to pass $675,000
estate tax free at death, and the amount increased to $1 million in 2006. With
proper estate planning, a married couple could shield twice the amount.
Under the newest estate tax law, the amount you can pass to heirs estate tax
free increases, as follows:
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Amount
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Year
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(Single/Married)
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2002
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$1.0 million/$2.0 million
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2004
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$1.5 million/$3.0 million
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2006
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$2.0 million/$4.0 million
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2009
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$3.5 million/$7.0 million
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2010
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Finally, the estate and generation-skipping transfer taxes are "repealed" after
2010. What's more, under the new tax law, the top estate tax rate slowly
decreases, from 50% in 2002 to 45% in 2009. Retained in the tax code is the
gift tax; eligible lifetime transfers will be taxed at the rate of 35%
beginning in 2010.
You may be thinking that you will never amass assets worth more than $3.5
million, or $7.0 million if you include your spouse's assets. And, if you're
under a certain age, you're probably fairly certain that you'll live past 2010.
Add those together and your conclusion may be that an estate plan is
unnecessary. And that could be a sizable mistake, for several reasons.
First, if the current the federal budget "surplus" evaporates, the scheduled
repeal of the estate tax may not occur. In fact, the legislation contains an
automatic sunset provision. Without an act of Congress, the new laws on estate
and generation-skipping tax will disappear at the end of 2010, and the rules in
effect in 2001 will be reinstated.
Second, there are other provisions in the new tax law, such as a change in how
beneficiaries will calculate the "basis" of assets, that may not prove to be
all that popular. It's possible that Americans may not wish to see the "new
system" remain in place once they understand more about how it works.
Third, a well-structured estate plan addresses needs other than tax reduction,
such as debt payment, asset investment and distribution of assets upon your
incompetency or death. If you fail to make provisions for these, the
legislature has a plan for you that will be put into effect through the local
probate court.
The bottom line: If the phased-in increase in the sum Americans can pass to
heirs estate tax free remains in force after 2010, it will make estate planning
easier, since the issue of taxes for most Americans will have been eliminated.
However, the issues of asset management, business succession, providing for
children of a prior marriage, providing for improvident children or children
while they are minors will all still exist, and are likely more important
issues to citizens than a debt called taxes.
If you'd like to review how the newest iteration of the estate tax laws might
impact your ability to provide for your family, please contact us.
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TRANSFERRING ASSETS TO THE NEXT GENERATION, AND TO THE
NEXT . . .
The more money you have, the more difficult the IRS makes it to pass that
wealth on to your heirs. The IRS will use the estate tax, gift tax, and
generation-skipping transfer tax to extract a heavy share of the money you
intend to take care of your children and grandchildren. Following are possible
solutions to the tax problems you may encounter in transferring money between
generations.
Estate and Gift Taxes
In one sense, these two are the same tax. If you transfer money while you're
living, gift tax may apply. Estate tax may apply if you make the transfer in
your will. As taxpayers, we each have one "unified" estate- and gift-tax credit
that shelters from tax a specified amount of transfers made during life or at
death. (The unified credit exclusion amount rises in steps from $1 million in
2002 to $3.5 million in 2009.) In addition, each of us may give up to $10,000
annually to each of any number of individuals without using any of our unified
credit. If a spouse joins in this gift giving, the annual limit doubles to
$20,000. (The annual exclusion is now $11,000, when adjusted for inflation.)
Assets are subject to estate taxes on the death of the owner. So, a family
strategy for avoiding estate taxes would be to transfer your assets directly to
your grandchildren in order to reduce estate taxes for your children. This type
of transfer, however, is not always tax effective. The generation-skipping
transfer tax (GST) may make it too expensive. When the GST applies to a
transfer of assets, it is in addition to an applicable gift and estate taxes.
You are allowed to make generation-skipping transfers of up to $1.10 million
free of the GST. (The GST exemption is adjusted for inflation.) The exclusion
doubles to $2.20 million if you and your spouse "split" the transfers. You can
divide your generation-skipping transfers among as many individuals as you want
while remaining within your total GST exemption. Also, please note that there
is one significant exception to the GST rule: If your child is not living,
there's no GST when you make a gift to your grandchild.
The identity of the person who is responsible for paying the GST depends on who
does the transferring. If you transfer your assets to a grandchild and your
child is still living, either you or your estate is responsible for the GST. If
you use a trust to transfer assets to your grandchild, however, either your
trust or your grandchild must pay the GST, depending upon the situation.
To Reduce the GST . . .
Consider the following if you plan to make transfers to your grandchildren that
are large enough to be affected by the GST:
- Pay your grandchild's tuition or medical expenses. If you pay these expenses
directly to the school or medical provider, all payments are exempt from both
the GST and gift tax.
- Transfer property that is growing in value. This is a way to escape gift,
estate, and generation-skipping transfer taxes because any increase in value
after you make the transfer is exempt from all three levies.
- Use the gift-tax annual exclusion and the GST exemption to your advantage.
Give the maximum $11,000 gift to each of your children, grandchildren, or other
heirs each year ($22,000 with your spouse). Over a number of years, you will be
able to transfer a substantial amount of your assets free of tax.
Having significant wealth to transfer to future generations is a fortunate
thing. Let us show you how to ensure that unnecessary taxes don't turn it into
a misfortune.
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HOW CHARITABLE GIVING CAN INCREASE YOUR FAMILY'S WEALTH
The tax laws offer valuable opportunities to those who care to seek them out.
For example, here's how you might use a charitable gift to increase the amount
of wealth you can transfer to your heirs.
Taking advantage of this opportunity involves three steps: creating a
charitable trust to generate a substantial income tax benefit, buying life
insurance with the tax savings, and letting the proceeds replace the donated
assets that otherwise would have passed to your heirs. The result can be a
substantial increase in the amount you will be able to leave to your children
or other heirs free of estate taxes, as well as the gratifying feeling that you
have supported a cause you favor.
Gaining a Tax Advantage
A charitable trust can separate the timing of your philanthropic gift from its
financial benefits to you. With a charitable remainder trust, you arrange to
make a future donation—of cash, appreciated securities, or other assets —to a
tax-qualified charitable organization of your choice. You place the gift assets
in the hands of a trustee for a term you choose. This can be up to 20 years, or
for your lifetime, or the lifetime of you and a beneficiary. When the term
ends, the trustee pays the trust's principal to the charitable organization.
But, during the term, you receive income from the trust.
The trust arrangement generates a substantial, immediate income tax deduction in
the amount of your future gift's present value—a percentage of the trust
assets' total value. This present value, calculated using IRS tables, is the
current fair market value less the actuarial present value of all the income
payments expected to be made from the trust. The shorter the term you choose or
the lower the payments you receive, the higher the deduction for your gift
becomes. The illustration below provides an example of how much the income and
deduction might be.
The Tax Value of a Ten-year Charitable Trust
| Fair market value of trust's assets (The principal of a charitable remainder
annuity trust. The charity receives the principal at the end of the trust's
term.) |
$750,000 |
| Annual payments to trust's maker |
$52,500 |
| Present value of ten years of payments |
$358,722 |
| Charitable deduction/charitable remainder |
$391,278 |
| Deductible portion of trust's value |
52 |
This is an example that assumes a 7% annuity rate, one $52,500 payment annually
at year-end, 7.60% table interest rate factor. The deduction would change
somewhat with earlier and more frequent payments and differences in the
interest rate factor.
Replacing the Gifted Assets
You use the tax savings derived from creating the trust to obtain life
insurance. As your situation requires, the policy's death benefit may be
payable after your death or after the deaths of both you and your spouse (a
second-to-die policy). The death benefit is not subject to estate taxes if a
properly structured life insurance trust is used. Insurance benefits are free
of income taxes to the receiving beneficiaries. Therefore, the policy will
provide your children or other heirs with tax-free assets that replace, or more
than replace, the funds you have donated.
Estate-Tax Impact
By making a charitable donation during your lifetime, you will remove the
assets from your future estate and, thus, protect them from the potential
effects of estate taxes. Taxable estate value beyond the amount that is
sheltered by each individual's unified credit is subject to estate taxes at
rates that range from 41% to 50%. (In 2002, the unified credit is enough to
shelter up to $1,000,000 of taxable assets.) So, simply donating $500,000 to
charity during your lifetime could reduce potential estate taxes by $205,000 or
more. But donating the same funds through a charitable remainder trust combined
with a wealth replacement life insurance policy can allow you to support your
charity and also transfer the $500,000 tax free to your beneficiaries.
Professional Help
The professionals at The Commerce Trust Company can evaluate whether this type
of trust would be a good strategy in your circumstances and determine the best
combination of term, payments, and policy. If you want to learn more about how
a charitable trust can increase the wealth that passes to your children, please
call us.
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