Will You Owe Estate Tax at Your Death?

Many people worry that they will owe estate tax at their death, but the reality is that fewer than 1% of all Americans will ever be subject to the estate tax. This is especially true (at least for the next few years) as a result of the sweeping tax law changes that took effect in 2001. Let's take a brief look at the most important provisions of the effect that new law had on the estate tax.

In looking at these changes, it helps to understand the following facts:

1. The Estate Tax Exclusion. Each individual has an exclusion against estate tax which is currently $1.5 million. This means that if you died today as a single person, and had less than $1.5 million in assets, then you would not be subject to the federal estate tax (whether you would be subject to your state's inheritance tax depends on your particular state's laws--in Texas, for example, you would pay no state inheritance tax if there were no federal estate tax paid). If you had assets in excess of $1.5 million, you would pay tax on the excess assets over $1.5 million, up to a top rate of 47%. However, the marginal rate for estates that barely exceed the exclusion amount would only be about 15-20%.

2. The Marital Deduction. If you are married, any gifts that you make to a surviving spouse entitles you to a deduction equal to the gift. Thus, if you and your spouse had $4 million in combined assets, and your share of the assets was $2 million, then you would be $500,000 over the exclusion amount. A gift to your spouse of all of your assets would reduce your estate to $0 because of the deduction ($2 million in assets less the $2 million gift to spouse = $0 estate for estate tax purposes). The problem with making an outright gift like this to the surviving spouse is that you have wasted your exclusion against the estate tax and your spouse now includes the full value of the assets you gave to him or her as part of their estate at their death, with only their exclusion to apply against the potential tax. In a future post, I will talk about eliminating this problem by utilizing a trust for the benefit of the surviving spouse that protects your exclusion while providing for your spouse's benefit at the same time.

From the inception of the law in 2001 through 2009 here's how the estate tax changes year by year depending on the year of death:

Year	Exclusion	Highest Rate
2001	$675,000	55%
2002	$1 Million	50%
2003	$1 Million	49%
2004	$1.5 Million	48%
2005	$1.5 Million	47%
2006	$2 Million	46%
2007/08	$2 Million	45%
2009	$3.5 Million	45%

If you die in the year 2010, there is no estate tax. The tax is repealed for that year only. So if you plan on dying, and your estate is large enough, perhaps that should be the year you do it. Unfortunately, the estate tax in that year is replaced by a capital gains tax on appreciated property you own at death, along with some other punishing tax changes that ease the pain of losing the amount of revenue the estate tax generated.

If you die after December 31, 2010 the federal estate tax returns to the same level as in the year 2002, i.e., the exclusion will be fixed at $1 million. The House and the Senate are in debate about whether to eliminate the tax entirely (unlikely) or to raise the exclusion to around $4 million on a permanent basis (more likely).

If you would like to estimate what your potential tax liability could be, you can go to this site and enter in your assets and debts, and it will calculate the potential tax you would have based on those assets and liabilities.

Having a good estate plan means knowing whether you could be subject to the federal estate tax and how to pay as little tax as possible through having the proper types of Wills and other documents. Don't penalize your future beneficiaries because you didn't adequately plan for their protection from unnecessary taxes.

Naming the Right Person as Your Executor

When making your Last Will and Testament, you probably put a lot of thought into who is going to receive your assets. I would argue that as much thought needs to go into who is going to administer your affairs after your death, because naming the wrong person can create a financial hardship for your beneficiaries. Understanding the roles played by the various appointees under your Will may guide you in selecting the right person for that role. This post discusses the role of the Executor and the importance of naming the right person for that position.

Your Executor is the person or entity (such as a bank or trust company) responsible for filing your Will for probate, collecting all your assets, selling property, paying debts and expenses, and filing tax returns. The Executor is NOT responsible for the investment and management of assets of the Estate (other than the continued preservation of the assets during the Estate administration) or for any trusts created under your Will, which is the responsibility of the Trustee. You can name more than one person or entity to serve as co-executors, if you choose, but you should remember that where two co-executors are named, if there is a disagreement between the executors, the estate administration may be delayed. For example, one executor may want to sell a piece of real property to provide cash for the beneficiaries. The other executor might believe the property has potential for growth in value and want to distribute the property directly to the beneficiaries and let them decide whether they want to keep it. If there is a stalemate, nothing can happen, and the property will remain both unsold and undistributed. Ultimately, the dispute might have to be taken to the probate court or to mediation to get resolution on the issue.

The Executor has complete authority over the administration of the Estate, so the person you name should be someone who is financially competent and who also understands the family dynamics. If you are married, in almost all cases the spouse is named as the Executor, but in some situations, such as where the spouse is incapacitated, lacks financial understanding or otherwise needs assistance with the management of the Estate, a child or sibling might be named as the Executor (or as a co-Executor with the spouse). If you are unmarried, a child, sibling or family friend can act as the Executor.

You should ask the following questions about the person you are thinking about naming: (1) Do I trust this person to handle the financial affairs for my beneficiaries? (2) Has this person ever had financial problems of their own? (3) Would they get along with the beneficiaries, and how would they handle conflict? (4) If I name co-executors, can the co-executors work together in harmony? (5) Will they accept advice from estate’s attorney, or will they be a loose cannon, acting without consideration for the consequences to the estate and the beneficiaries?

If you answered "no" to any of these questions, you should strongly consider naming an alternative person as the Executor.

In larger estates, banks and trust companies might be considered because of the complexity of the assets and their expertise in handling such assets. They specialize in their ability to come in and collect all the assets and administer the transfer of closely held businesses and partnership interests in a more efficient and timely manner than perhaps the family member or friend would. Banks and trust companies are also helpful in larger estates where you have no one to otherwise name that has any financial expertise to continue the administration of the estate assets. Of course, the downside to naming a bank or trust company is that they will charge for that expertise. You can expect to pay a corporate fiduciary anywhere from 1 to 3% of the overall value of the estate assets as a fee for their services as executor. Thus, where the estate is valued at $2 million, and the executor charges a 2% fee for its services, the cost to the estate would be $40,000. In some instances this is well worth it; in other cases you are best served just hiring a well-qualified attorney (which you should always have in any event) to guide you through the administration process.

One other note: it used to be that you needed to name someone that lived nearby to facilitate the administration process. With today’s technology, you can name someone who lives in another city or even another state without hindering the estate administration. Many transactions can be done through the mail, by messenger, online or over the phone.

You have probably given a lot of thought into how you are going to have your Estate assets pass at your death. Don’t put someone in charge who will derail everything after your death that you’ve worked so hard to accomplish during your lifetime.

The General Durable Power of Attorney

Planning for disability is an important part of your overall estate planning and one part of the plan that many people tend to either overlook or not prepare for well enough. They think having a Last Will is enough, because they never believe they might eventually become incapacitated. We all know that death is inevitable, so after your death almost any matter can be easily handled with a well-drafted Will that properly distributes all your assets and names competent persons to handle those affairs. But what happens if you become incapacitated and remain in that condition for months or even years? Do you have someone you can trust to manage your personal and financial affairs for you while you are still living? Good estate planning means planning for the unexpected, even it the unexpected is unlikely to happen. Two important documents in your disability planning arsenal discussed in previous posts are the Directive to Physicians and the Medical Power of Attorney.

A General Power of Attorney (“GPOA”) is an important part of the disability planning arsenal. A GPOA is a document that allows a person that you appoint (known in various states as either the “agent” or “attorney in fact”) handle the powers set forth in the instrument. The powers given can be very broad (allowing the agent to do practically anything that you could do if you were not incapacitated), or limited (allowing the agent only to do certain acts). Having a GPOA can also eliminate the necessity of having a costly and time-consuming guardianship created, where all matters concerning your finances are governed by the local probate court. Banks, financial institutions, title companies and others are authorized to deal with your agent so there is no disruption in the management of your financial affairs.

Under the old common law, a power of attorney would terminate immediately upon the death or disability of the person (the “Principal”) creating the power. Death still terminates the power in all states, but now most states provide that the power of attorney can be durable, meaning that the fact that you are incapacitated does not terminate the ability of the agent to act. However, the Principal must specifically provide in the written instrument creating the power that it will be durable. If that language is not there, the power of attorney is only effect if you are not incapacitated.

In addition, the power can be made effective immediately, or it can be made effective only in the event of the Principal’s incapacity. How is incapacity determined? Usually, incapacity can be determined in a written letter signed by the Principal’s treating physician. In most cases, the power of attorney is made effective on disability, since you still have the power to act on all your matters if you are not incapacitated. However, some people have physical disabilities that make it difficult to go to the bank, write checks or sign documents, so having a power that is effective immediately makes sense for them.

In naming an agent to handle your affairs, make sure the person you name is trustworthy and competent. Since the agent can do anything with your assets that you could do, they also have the ability to write checks to themselves or for their own benefit. Conflicts could arise between the agent and other people who might have an ultimate claim to your estate at your death. For example, you might name one of your three children as your agent, and that child goes out and writes large checks for his own benefit. The other two children get wind of this and sue their sibling for his mishandling of the power. Mismanagement is rare, but extreme caution should be exercised.

The GPOA in some states must be recorded in the deed records of the county where the Principal resides to be made valid. In Texas, however, the GPOA must be recorded only if it is intended to be used for real property transactions. If the GPOA is recorded, it can only be revoked by a written revocation filed in the same deed records.

Finally, the GPOA is rendered useless if the person you name dies, resigns or becomes disabled. You should therefore consider naming a successor or successors in such an event.

Four Things You Need to Have in Your Last Will and Testament

In various posts, I have discussed the importance of having a Last Will and Testament and the time, trouble and money having one will save your family. Even a simple Will (if done correctly) is better than not having one at all (see my June 8th and June 9th posts). The type of Will you need will typically depend on the size and complexity of your assets, but all Wills, simple and complex, should have at least the following four things spelled out clearly:

1. A complete distribution of all your assets. This sounds simple enough, but you would be surprised at how often this doesn't happen, especially for those people utilizing the "do-it-yourself" method of Will writing. Make sure that your Will provides a "Residuary" or "Rest and Remainder" clause that make a distribution of all your remaining assets after any specific bequests are made. A failure to have this clause will result (in most states) in a portion of your estate passing by intestacy.

2. Make sure you have contingent beneficiaries named. What if you created a Will and no one was around to accept the benefits? For example, let's say Joe is unmarried. Joe has a Last Will that provides "I leave all of my residuary estate in equal shares to my sister Betty, my brother Bill, and my brother Bob." The Will makes no other provisions for distributions. Bill predeceases Joe, leaving two children who survive him, Tom and Sally, neither of whom liked Uncle Joe. Joe would have never wanted Tom and Sally to receive Bill's share, but since there is no provision in the Will for what would happen in the event Bill predeceased Joe, the share passing to Bill would now pass under the intestacy laws of the state where he resided at his death. The likelihood is that some portion of that share will indeed pass to Tom and Sally. Make sure you spell what happens if someone named in your Will predeceases you. Does it go to that person's spouse, or to his descendants, or to some other person or persons? Don't assume everyone you name in your Will is going to survive you.

3. Have you named executors, trustees and guardians (and successors to them)? Again, a simple matter, but one that stumps some people--not because they failed to name the initial executor, but because they failed to name a backup to the first executor. Just recently I had to deal with a Will where the Decedent named his wife as his executor, but not anyone to succeed her if she failed to serve. Sure enough, she died seven months after he did, and because of complications with several beneficiaries named in the Will it took almost two months to get the probate court to name a successor. My rule of thumb is to always name the initial person, followed by no less than two (and preferably three) successors. This is particularly important for guardians for your minor children, where many times the initial appointees may decline to serve because they don't feel like they can handle the burden of additional children in their household. Don't take a chance on the court appointing someone you might not agree with in a fiduciary role for your estate or as a guardian for your children. Have a solid line of succession and make sure you go back every so often to double-check it.

4. Waive the bond for your named appointees, and also make sure they have all the necessary powers they need. If you don't waive the bond for the named executor, trustee or guardian you name in your Last Will, the court can require the named person post a bond equal to or exceeding the size of the liquid assets of the estate. This might be prohibitive in some instances and the named person may not be able to qualify for the bond. A simple clause waiving the bond for any person named to a fiduciary capacity in your Will eliminates that concern. In addition, make sure that you are giving the executor and trustees all the powers they need to administer the estate or the trust without court interference. In Texas, for example, if you name the executor an "independent" executor, they can serve without court supervision. Other states may have similiar provisions for limited court oversight of the estate administration process. Also, give them the power to do anything they need to do regarding estate assets, such as the ability to sell real property. Believe it or not, in Texas, if you don't give the executor that power, he cannot sell real property without first attaining court approval of the sale (even where he is an independent executor)!

Wills can be extremely complicated documents, which is why lay persons typically make mistakes when trying to draft them as a way of saving money. The result is that it usually costs more in legal fees to fix the problems created by the poor drafting than if the person had just paid a qualified attorney to draft a proper to begin with. Don't be penny wise and pound foolish when it comes to something as important as your estate.