The exemption level is set to increase to $3.5 million in 2009. Then, the federal estate tax is completely repealed for 2010. The bad news: The favorable estate-tax rules “sunset” in 2011, meaning the federal estate-tax rules will revert to the old-law system, (with a paltry $1 million exemption level), unless Congress acts.
Advice: Take a fresh look at your will for 2006. Even though estate-tax reforms seem to have stalled, you might need to update your will to accommodate the increase in the exemption level for 2006.
That’s particularly true if you’ve established a “credit shelter trust” to maximize a tax-free transfer of assets.
Let’s say that a few years ago you set up a testamentary trust (i.e., via your will) based on the federal estate-tax exemption. The trust is designed to pay the maximum allowable tax-free to heirs (such as your kids) and then leave the excess value to your surviving spouse.
But now there’s a crimp in the plan. On Jan. 1, the estate-tax exemption rose from $1.5 million for 2005 to $2 million for 2006. That means your will may—if it’s tied to the exemption amount—be allocating too much or too little to your surviving spouse … and it may need an update.
Example: Say you currently own assets worth $2 million. Your will leaves an amount equal to the estate-tax exemption level to the trust set up for your kids; the remaining amount goes to your spouse. That worked fine for 2005, when the credit sheltered transfers of $1.5 million. The excess $500,000 would go to the spouse outright, leaving her with enough to live on, without having to ask the trustee.
But in 2006, the exemption limit rises to $2 million. With that higher amount, all of your $2 million in assets would (according to the will) transfer to the kid’s trust. Your surviving spouse receives nothing.
Possible solutions: Revise your will to stipulate a specific dollar figure to fund the trust. Or, cap the trust’s funding at one-half the estate’s amount. In other words, if your estate is $2 million and you died in 2006, the trust would be funded with the lesser of $2 million (the exemption limit) or $1 million (one-half the value of your taxable estate).