Tax Exemptions

Last year we performed a survey to find the top ten reasons why people prepare a Revocable Living Trust. What we found was what we expected. The number one reason people are interested in a Living Trust is to minimize estate taxes.

Much of the estate planning process focuses on reducing or eliminating taxes. The U.S. government imposes a tax on the transfer of your property to others both during your lifetime and when you pass away. This tax is known as the Unified Gift and Estate Tax.

In 1976, 1981, 1986 and then in 2001, Congress extensively overhauled the federal estate and gift tax laws. With the exception of a law providing for a marital deduction in 1948 these were the first major changes in these laws since 1942. As a result, death tax payments were assessed only against the wealthy and the moderately wealthy. With these laws, the majority of the population benefited since smaller estates did not have to pay estate taxes.

Who needs to worry about estate taxes

As explained above, not everyone has to worry about paying federal estate taxes. If your estate falls under the government exemption your trustee/executor does not have to file an estate tax return (Form 706) and pay the required tax within 9 months of your death.

Unfortunately, many people feel confident that their estate will pass without the threat of paying estate taxes. However, most do not adequately calculate the value of their estate. With careful calculation many find that their estate values are over the exemption rate.

It is important for you to realize what property will be included in your estate for federal estate tax purposes. The estate includes all property owned by the decedent at the time of death: investments, cash, real estate, vehicles, personal property, life insurance proceeds from policies owned by the decedent within three years of death, life insurance paid to the estate, retirement assets and business interests.

The gross estate also includes assets passing through probate as well as assets inherited directly by joint owners or beneficiaries. This includes part interests, intangible property, property placed in a revocable living trust and other interests transferred by a decedent who retained control or an interest in the property.

Once calculated, you may be surprised to find your net worth.

Who will have to pay estate taxes?

Your estate will have to pay estate taxes if the net value (gross assets minus debts) when you die is more than the exemption amount set by Congress. The exemption equivalent is available to each U.S. citizen or resident. However, under the new tax law signed June 7, 2001 by President Bush, the estate tax will be gradually decreased until it falls to zero in 2010. Then on January 1, 2011, the estate tax law will revert to current tax laws unless Congress revisits the issue. See table ET-1 for the exemption equivalent. For your benefit we compared the old law to the new law.


Table ET-1 (Estate and Gift Tax Rates and Unified Credit Exemption Amount)
Old New
Year Exemption Equivalent Top Rate Year Exemption Equivalent Top Rate
2001 $675,000 55% 2001 $675,000 55%
2002 $700,000 55% 2002 $1,000,000 50%
2003 $700,000 55% 2003 $1,000,000 49%
2004 $850,000 55% 2004 $1,500,000 48%
2005 $950,000 55% 2005 $1,500,000 47%
2006 $1,000,000 55% 2006 $2,000,000 46%
2007 $1,000,000 55% 2007 $2,000,000 45%
2008 $1,000,000 55% 2008 $2,000,000 45%
2009 $1,000,000 55% 2009 $3,500,000 45%
2010 $1,000,000 55% 2010 No Tax Repealed
2011 $1,000,000 55% 2011 $1,000,000 55%

The new law increases the exemption amount and reduces the top tax rates over the next several years. For example, if you die in 2005 with a net worth of $1,300,000. Your heirs will not pay any estate tax. If the law had not changed, then your heirs would have had to pay tax on $350,000 ($1,300,000 minus the old 2005 exemption of $950,000). However, if Congress does nothing to extend the law before January 1, 2011, it will revert to the existing tax law.

State Tax

On the state tax level the state death tax credit allowed against estate tax will be reduced by 25 percent in 2002 (from present law amounts), 50 percent in 2003 (from present law amounts), 75 percent in 2004 (from present law amounts), and in 2005 completely repealed after which there will be a deduction for death taxes. To find out more information on state death taxes, we recommend speaking with a CPA in your area.

Gifting Considerations

The gift tax will not be repealed. Instead, the new law creates a $1 million lifetime gift tax exclusion, beginning in 2002. And gift tax rates will gradually decline. In 2010, the maximum gift tax will be 35 percent ‚ the top individual income tax rate.