The Federal Estate Tax was created in 1916 to help pay for World War 1. The tax is levied on everything you own or have interests in at your death. At first, it did not apply to many people but inflation and prosperity began taking its toll. From 1987 to 1997 the government tax on estates over $600,000 was 55%.
By then, many people who owned a nice home and had savings and investments became worried that a lot of their money want going to go to the government rather than their heirs. Each person has his or her own exemption. A married couple has two exemptions. However, if one died, leaving everything to the spouse, the surviving spouse only had one exemption left.
The legal profession came up with an answer: the A/B Trust otherwise known as the “spousal” and the”family” trust. Under current law, you can leave an unlimited amount of money to your spouse free of tax. But you can leave up to $600,000 to a trust that your spouse can use for his or her benefit but is not legally their property. This is known as the “family trust.” The rest goes directly to the spouse or to a “spousal trust.”
Then when the surviving spouse dies, the heirs inherit both the “family trust” assets ($600,000) and the surviving spouse (or “spousal trust”) assets up to the $600,000 limit – for a total of $1,200,000 free of federal estate tax.
At a tax rate of 55%, that saves the heirs a whopping $330,000 in taxes. Everyone thought that was a great idea. Many estate plans and trust documents were prepared with these issues in mind. There were some drawbacks with these plans but the estate tax savings overwhelmed all other considerations.
Beginning in 1988 the amount of the exemption that could be passed on to non-spousal heirs was gradually increased. In 2000 it went to $1,000,000 and for one year – 2010 – there was no estate tax at all. In 2012 the law was changed and the limit was raised to $5 million and indexed for inflation. In 2016 the estate tax exemption is $5.45 million and the estate tax rate is 40%.
This means that a lot fewer people will be subject to the estate tax and now are faced with the negative aspects of this approach to estate planning. These include
- Administrative costs
- Capital gains taxes
We will address these issues in our next essay.
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