When I speak to clients regarding their final affairs and planning the future settlement of their estate, nearly every client is not concerned with the federal estate tax or the Tennessee Inheritance Tax. Quite frankly, I can understand why our clients are not concerned. First, the federal estate tax only applies to gross estates exceeding $5.25 million in value, and with portability, the federal estate tax may only apply to gross estates exceeding $10.5 million in value. Second, the Tennessee Inheritance Tax only applies to gross estates above $2 million in value, and the Tennessee Inheritance Tax will be completely phased out in 2016. Therefore, most clients that I speak to are simply not concerned with the federal estate tax and the Tennessee Inheritance Tax.
However, nearly every client that I speak with will believe that their life insurance proceeds are not part of their estate because of beneficiary designations and the fact that these assets pass directly outside of probate. Although, that is true, the federal estate tax does apply to your gross estate. For example, let’s say that that John owns a house, a car, a bank account, and a retirement account totaling $5 million. Now, John only had a Will, so all of his assets will pass through probate. However, John also has a $10 million life insurance policy and is son James is named as the beneficiary. Therefore, when John dies, what John really has is a $15 million gross estate, thereby making $9,750,000 in assets subject to the federal estate tax, which has a top tax rate of 40%.
However, there are certain specific estate planning strategies that you can implement in order to avoid the federal estate tax on a gross estate that takes you over the applicable federal estate tax exemption limit. One way to limit your exposure to the federal estate tax is to establish an Irrevocable Life Insurance Trust, which is funded by with your life insurance policy. However, please note that an Irrevocable Life Insurance Trust is irrevocable, meaning that once you create it you can never destroy it. In addition, there are a number of other special rules that you must following including time period between when it is set up and funded and when you die, and who the trustee of the trust is allowed to be.
If you are in this situation or have other questions regarding taxes, estate planning, or making your estate settlement process simple for the family you leave behind, then I encourage you to attend one of our many free seminars that are held every month throughout the greater Nashville area.