The Federal estate tax has a confusing near future.  The exemption is now $2 million per estate and goes to $3.5 million in 2009.  In 2010 the tax is slated to disappear entirely.  Under the law as now written, the tradeoff for no estate taxes would be the loss of the “stepped-up basis” that now benefits estates by essentially forgiving capital gains at death.  Then in 2011 the exemption would revert to $1 million.  From what we hear a likely result is legislation in late 2009 to keep the estate tax, and perhaps the $3.5 million exemption, in place indefinitely.  We can’t be sure.

Washington is one of a handful of states with an estate tax.  The exemption for Washington State is currently $2 million per estate, with no adjustment scheduled.

The combined Federal and State tax rate is about 50%.

Our overall approach to this is pretty simple.  The estate tax probably won’t go away, so if you can afford it make tax-saving gifts during your lifetime to those who will be receiving your estate.  Here are a few more specific ideas.

1. Take advantage of the gift tax annual exclusion.  You can give $12,000 per recipient per year, tax-free.  And so a married couple can give $24,000 per year.  It needn’t be in cash, and it may be into a trust if done properly.  The compounding benefit of this is great; annual gifts by a couple to three children for ten years, assuming a %6 investment return on the assets given, will result in about $1 million kept out of the taxable estate, saving roughly $500,000 in tax.
   
   
2. Pay education and medical expenses directly.  Any direct payment of tuition of medical expense (including medical insurance) for a child or grandchild or anyone else, doesn’t count as a gift.
   
   
3. Consider “taxable” gifts.  You can give up to $1 million in your lifetime, in addition to the excluded gifts described above.  These are called “taxable” gifts, but they really only use a portion of your now $2 million estate exemption and there is no immediate tax on them.  These gifts allow you in effect to make a tax-free gift of the appreciation in value of the assets after the time of the gift.  An added benefit is that the gifts don’t count toward your Washington State estate tax exemption (only the Federal).
   
   
4. If you’re married, make sure you have Wills in place that will use both of your exemptions.  This may usually be accomplished by having the right sort of Wills that place the first estate in trust for the lifetime benefit of the surviving spouse, rather than giving it to the surviving spouse outright.  Where the couple’s holdings are unequal, further measures may be needed.
   
   
5. Give away life insurance.  The full amount of life insurance proceeds is taxable in your estate, unless you give the actual ownership of the policy to your kids, a trust for them, or charity.  Just making your kids the beneficiary doesn’t get it out of your estate.  Keep in mind that you need to live for three years after the gift to make this work, and that you will be deemed to have made a gift of the cash value of the policy.
   
   
6. Consider a personal residence trust.  This is an increasingly popular way of getting your residence out of your estate at a reduced value.  You would put your primary residence or vacation home in a trust.  For a period of years you’d be the beneficiary.  After the trust term ends, the ownership passes to your children, or a trust for them.  Because of the interest you retain for a time, the value of the gift is reduced and you use less of your exemption in passing this asset to your children.
   
   
7. Consider other techniques.  There are other arrangements that can significantly reduce estate taxes, including but not limited to family partnerships, generation-skipping trusts to protect family assets and keep them from being taxed again in your kids’ estates, GRATs that allow you to retain income for a period of years, and numerous ways of helping your favorite charities.
   
   Please feel free to call us with questions on any aspect of your estate planning.  Members of our Trusts & Estates Group include Julie Dickens, Alan Macpherson, Eileen Peterson, and Sandy Rovai.