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Estate Tax Changes on the Horizon

Last update on: Jun 23 2020
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Hurricane Katrina and other factors put on the back burner permanent changes to the estate and gift tax. The plan was to have a permanent change to the estate tax enacted in fall 2005. For now, however, we continue to live with the scheduled phaseout that was enacted in 2001. Under this schedule, taxes will continue to fall through 2010, and then the old estate and gift tax will return in 2011 if Congress does not take some action.

Here are the schedule changes to expect for 2006.

  • The lifetime estate tax exemption amount will increase to $2 million from $1.5 million in 2005. The next scheduled rise in the exemption is to $3.5 million in 2009. Then, it is unlimited for 2010, eliminating the estate tax. The lifetime gift tax exemption limit stays at $1 million. 
  • The estate tax rate will decline to 46% from 47%. 
  • The annual gift tax exclusion will increase to $12,000 from $11,000 in 2005. 

These changes will result in significant savings for estates that are taxed in 2006 instead of 2005. For example, a $2 million estate of a single person would pay $225,000 in estate taxes in 2005 but $0 in 2006. For a $5 million estate, the savings would be about $255,000.

While beneficial, these changes can be damaging if your will and the rest of the estate plan are not updated to incorporate all the effects of the changes.

For example, the will for a married person with adult children typically says that a portion of the estate equal to the estate tax exemption amount will be left in trust with income to the surviving spouse and the remainder to the children. The rest will be inherited by the spouse. This approach ensures that the estate tax exemption of the first spouse is fully used to reduce estate taxes.

The clause made a lot of sense when the exemption amount was only $650,000. But for in a $3 million estate, the spouse receives outright only $1 million in 2006. The will needs to be adjusted to reflect the new exemption.

It is not necessary to rewrite the will every time the exemption amount changes, as some advisors recommend. Instead, consider using a limiting clause. For example, the will can say that the trust will receive either the lesser of the exemption amount and a dollar amount set in the will. You set this amount based on the maximum amount you are comfortable shifting away from your spouse.

Another danger is overdoing lifetime gifts. It is a good idea to establish a lifetime giving program to get appreciating property out of your estate now. The higher annual gift tax exemption makes that easier. In 2006 eEach spouse can give up to $12,000, or $24,000 jointly, to each beneficiary.

The danger is giving away too much. Be sure to retain enough wealth to maintain your standard of living and to pay for emergencies, such as unexpected medical expenses. Be sure the estate plan is integrated with your retirement plan.

Changes in the estate tax are a good time to revisit your estate plan. Consider other changes in your life and visit your estate planner. Events that need to be incorporated in the plan are changes in your net worth, purchases or sales of major assets, additions to or subtractions from the family (grandchildren being born or children getting divorced), and changes in your wishes.

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