Estate tax—maximizing benefit of exemption

If you own a home and some life insurance and are entitled to retirement plan benefits from work, your gross estate may already exceed the threshold at which estate tax liability begins. (In 2000 and 2001, that threshold is $675,000; it will gradually rise to $1 million by 2006.) Since estate tax rates begin at 37% and rise to 55%, planning to make the best use of your exemption is essential.

In 2000 and 2001, you are entitled to a credit against estate (or gift) tax of $220,550. This credit exactly equals the federal estate (or gift) tax on $675,000, thereby exempting from tax the first $675,000 of your taxable estate (or taxable gifts made during lifetime). Your spouse is entitled to an additional credit of $220,550.

If the value of all assets owned by you and your spouse exceeds $675,000, an estate plan which results in the surviving spouse receiving all the assets will result in estate tax liability at the death of the second spouse. This, in turn, reduces the amount available for your children or other beneficiaries.

A married couple can escape estate tax on assets of up to $1,350,000 if the couple's wills are drafted to take full advantage of each spouse's own credit. The wills should provide that, when the first spouse dies, the amount protected from estate tax by the available credit passes to a trust (the "credit shelter trust") from which the surviving spouse can benefit during his or her remaining lifetime but which will not be included in the surviving spouse's estate at death. The following example (which uses the exemption amount that applies in 2000 and 2001) illustrates the tax savings that result from using a credit-shelter trust in the will of the first spouse to die instead of leaving the entire estate outright to the surviving spouse.

Assume you and your spouse have assets worth $1 million and $350,000, respectively. If you leave your entire estate outright to your spouse, there will be no estate tax at your death because your $1 million qualifies for the marital deduction in your estate. However, when your spouse dies, her estate includes the $1 million inherited from you (assuming no intervening changes in wealth) plus her own $350,000, resulting in a federal estate tax of $270,750, determined as follows:

  • Gross Estate: ..................................................... $1,350,000
  • Marital Deduction: ............................................................. 0
  • Taxable Estate: .................................................. $1,350,000
  • Estate Tax: .......................................................... $ 491,300
  • Less unified credit (2000 and 2001): ........................ - 220,550
  • Tax Due: ............................................................... $270,750

After the estate taxes are paid, $1,079,250 is left for the children.

If, instead, your will provided that an amount equal to the estate tax exemption ($675,000 in 2000 and 2001) passed to a trust from which your spouse and/or children would receive income and could have principal paid to them if they needed it, and the balance of your estate ($325,000) passed outright to your spouse, the tax result would be:

Your Estate

  • Gross Estate: ..................................................... $1,000,000
  • Less Marital Deduction: ........................................... 325,000
  • Taxable Estate: ....................................................... 675,000
  • Estate Tax: ............................................................. 220,550
  • Credit: .................................................................. - 220,550
  • Tax Due: .......................................................................... 0

Your Spouse's Estate

  • Gross Estate (her own $350,000 plus the $325,000 inherited outright from you): .................................................................... $675,000
  • Marital Deduction: ............................................................. 0
  • Taxable Estate: ..................................................... $675,000
  • Estate Tax: ............................................................ 220,550
  • Credit: ................................................................. - 220,550
  • Tax Due: ......................................................................... 0

Thus, the full $1,350,000 is available for the children.


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