When I began my intensive study of estate planning in the graduate tax law program at Boston University, I was struck by what initially seemed unfair and unjust, and later proved to be simply instances of poor estate planning. The injustice, after working diligently all our lives, paying federal and state income taxes at a combined rate of approximately 41% (of course, depending on one’s state of residence and level of income), we die, only to have the federal government tax our property after death at a rate in excess of 40% for estates in excess of One Million Dollars (the tax rate climbs to 55% for amounts over 3 Million Dollars).
With careful estate planning, however, estate and gift taxes may be dramatically reduced. For example, although estates in excess of 10 Million Dollars are taxed at a rate of approximately 60%, Jackie Onasis' estate of approximately 200 Million Dollars was taxed at an approximate rate of only 2%. This was accomplished using a charitable lead trust, now popularly referred to as a JOLT ("Jackie Onasis Lead Trust") in honor of you know who. We might say, that's because large estates are the ones able to take advantage of tax loop holes or the rich are the ones who can afford expensive estate planning legal fees. That, however, is not true. Legal estate planning advice is advisable for all estates of ANY size and absolutely necessary for estates exceeding the unified credit limit under Section 2010(c) of the Internal Revenue Code, 26 U.S.C. 1 et. seq. (the "Code") of $650,000 for 1999. Indeed, techniques are available which help reduce taxes or ease administrative burdens for estates of any size. Moreover, the cost of expert legal estate planning advice is quite reasonable when considering the costly consequences of inadequate planning.
Estate planning advice is common, very good and sound estate planning advice must be sought. For this reason, there are quite a few mistakes made in estate plans. Due to space limitations, I will discuss only a few of the most common and basic of them. Review the points below and then answer the question "How does my estate plan rate?"
Holding property as joint tenants with rights of survivorship or as tenants by the entirety means that upon the death of one joint tenant, the property will pass outside the decedent's will directly to the surviving joint tenant. Thus, if you have taken the time to carefully plan out the disposition of your property pursuant to a will, but hold your property jointly, your efforts at directing the disposition of your property will be lost since the will will be of no effect. The property held jointly will pass to the surviving joint tenant no matter how the will directs the disposition of the property. For example, suppose a husband, in a second marriage and with children from a prior marriage, writes a will leaving all of his assets to his second wife for life, remainder to his children. If the husband and second wife hold assets jointly, those assets will pass to the second wife outright. The second wife may then leave the assets to whomever she pleases and exclude the husband's children from the prior marriage.
Further, holding too much property jointly may defeat optimizing any benefit from the federal unified credit/tax exemption under Section 2010 of the Code. To optimize use of the unified credit, each spouse should hold assets of a value up to the exemption amount, which may pass estate tax free to a credit shelter trust. If drafted properly, the trust should allow the surviving spouse to be a beneficiary of the credit shelter trust without the trust being includable in the surviving spouse's estate. In that way, the assets of the trust will pass estate tax free for use by the spouse, children or any other desired beneficiary.
Similar to the problems with too much property held jointly, simply having reciprocal wills through which spouses leave assets to each other, may defeat effective use of the unified credit/tax exemption. If assets simply pass outright to the surviving spouse, these assets will be includable in the surviving spouse's estate and may be subject to tax. To optimize the exemption, assets should pass to a trust, which will not be includable in the surviving spouse's estate.
Although insurance proceeds are generally excluded from income tax pursuant to Section 101 of the Code, Section 2042 of the Code will cause life insurance proceeds to be included in the decedent's estate and subject to estate tax, if such proceeds were payable to or for the benefit of the decedent's estate or the decedent held any "incidents of ownership" in the policy. Thus, if the insured owns a life insurance policy on his or her own life, payable to the surviving spouse or children upon death, the decedent holds incidents of ownership in the policy. Consequently, the life insurance proceeds will be subject to the federal estate tax unless excluded through the Section 2010(c) exemption or the Section 2056 marital deduction. Further, while the insured may avoid "incidents of ownership" by having the surviving spouse own the insurance policy with a child listed as the policy beneficiary, this structure gives rise to a federal gift tax. Where a surviving spouse owns an insurance policy on the decedent spouse's life with their child listed as beneficiary, under the federal tax laws, the surviving spouse will be deemed to have made a gift to the child of the policy proceeds.
Accordingly, the entire proceeds will be subject to the federal gift tax with approximately the same result as if the proceeds had been subjected to the federal estate tax. The solution to these problems is to ensure the beneficiary of the policy is the policyowner or to place the policy in an irrevocable life insurance trust. An irrevocable life insurance trust is especially useful where the beneficiaries are minors or are otherwise financially unsophisticated.
While in most states divorce will invalidate a gift under a will to an ex-spouse, this is not always true of contractual documents, such as insurance policies, on which divorce typically may have no legal effect. If you are divorced, take the time to carefully review the designated beneficiaries under all insurance policies with your insurance agent. In too many instances, the main asset of a decedent’s estate is insurance proceeds that are inadvertently left to the divorced ex-spouse, leaving children and other more desirable beneficiaries out in the cold. Further, while the Model Uniform Probate Code ("MUPC") recommends laws which annul provisions for a former spouse not only in wills, but in other donative transfer documents, such as insurance policies, revocable trusts and similar instruments, if your state has not adopted the MUPC or even if it has, it is wise to revise your beneficiary designations upon divorce in your will, any trust, along with the revisions to your insurance policies.
While these points are merely the tip of the iceberg, they should help to raise your awareness of the sometimes devastating impact of overlooking
what appear to minor items in arranging your estate plan. There is no time like the present to obtain an expert review of your estate plan by a competent estate planning professional.
Melissa Cassedy Wesel, Esq., L.L.M.