ComproTax Talks!

July 02, 2007: 08:05 PM EST

Jul. 2, 2007 (Investor’s Business Daily) –

Today’s Democratic-led Congress looks unlikely to repeal the federal estate tax.

So your best course of action may be to stay alive. But in the unpleasant event you can’t, careful planning will preserve more of your hard-won assets for your heirs. First, you need to understand how the death tax works.

At your death, all of your assets will be tallied. That includes easy-to-value items such as bank accounts and publicly traded securities.

Other assets are harder to value. Real estate, collectibles and shares of private companies are examples.

But your estate executor must find reputable appraisers for those items. The valuations may have to withstand a challenge if the IRS decides they’re too low.

The total value of your estate will be reported on an estate tax return, Form 706. It’s due within nine months of your death.

A six-month filing extension is available. But any tax due must be paid within the original nine months.

On this return, certain deductions from your gross estate are allowed. Generally, bequests to your spouse and to charity escape estate tax.

Outstanding liabilities also may be deducted from your gross estate. The balance is your taxable estate.

In addition, you can exclude a set amount from taxation. That exemption rises periodically.

“The amount is now set at $2 million,” said Blanche Lark Christerson, managing director at Deutsche Bank (NYSE:DB) Private Wealth Management, New York.

Here’s a simplified example. Say a hypothetical John Jones dies in 2007. Suppose he has $5 million in total assets and no outstanding debts. He has not made any gifts that would eat into his estate tax exemption.

Imagine that Jones leaves $2 million to his wife and $400,000 to charity. The remaining $2.6 million is his taxable estate.

Prioritize Payments

He can exempt $2 million from estate tax. That would leave $600,000 subject to tax. The current rate is 45%.

So Jones’ estate would owe $270,000. Depending on where he lived, state tax also might be due.

Any state tax paid can be deducted from Jones’ federal taxable estate. That makes it a good idea to pay the state tax first.

The same rules will apply if Jones dies in 2008. But things get complicated after that unless there is a change in the law.

In 2009, the federal estate tax exemption goes up to $3.5 million. Jones’ $2.6 million taxable estate would owe nothing to the IRS.

Federal estate tax will not be collected from the estates of people dying in 2010. But in 2011, the estate tax exemption would be re-set at $1 million.

If Jones dies then, with a $2.6 million taxable estate, under current law there would be estate tax owed on $1.6 million. That $1.6 million would be taxed at graduated rates from 41% to 53%.

Larger estates would owe tax at rates up to 60%.

So planning is hard. You don’t know when you’ll die, what the exemption will be then or what tax rates will be in effect.

“One strategy is to plan as if death will occur under current law,” Christerson said. That might mean assuming death will occur in 2007 or 2008. Be ready to adapt your plan when any changes are passed into law.

Develop your plan with a professional experienced in estate tax. Chances are he’ll want to include some basic strategies. A key technique involves juggling spousal assets.

For example, married couples may want to hold assets so that both spouses’ estates can use the tax exemption. That will be true no matter which one dies first.

Suppose Bob Smith has $6 million in assets but his wife Jane has only $200,000.

If Jane dies first, only $200,000 can be left to their children from her estate, free of estate tax.

That would leave Bob with a $6 million estate and no spouse to inherit some assets. If he dies in 2007 or 2008, he would have a $6 million taxable estate.

Smith could leave $2 million to the children, tax-free, thanks to his exemption. But the other $4 million would be subject to estate tax. At 45%, the federal estate tax bill would be $1.8 million.

Helping Heirs

The family would get to keep more if Bob had given Jane $1.8 million of assets. That would bring her assets up to $2 million, same as the exemption limit. Whichever spouse dies first in 2007 or 2008 could leave $2 million to their children, tax-free.

Of the couple’s $6.2 million in total assets, a total of $4 million could eventually pass to their children exempt from estate tax.

That would leave $2.2 million subject to estate tax and a $990,000 tax bill, at a 45% rate. In this simplified example, redeploying spousal assets saves the family over $800,000 in tax: the estate tax would be $990,000, not $1.8 million.