Warning: Not Paying Attention to the Estate Tax Can Be Very Dangerous For Your Family

This morning, I wanted to write an article about the federal estate tax. There has been a lot of talk about the federal estate tax by the media, financial advisors, accountants, and other financial gurus. Some even state that given the estate tax, estate planning is no longer needed. However, as I have said in previous articles, estate tax is a very small part of estate planning. Proper estate planning includes incapacity planning, probate avoidance, ease of transfer at death, legacy preservation, wealth preservation, asset protection, income tax planning, protecting your children’s inheritance, and planning due to a remarriage.

However, in this article, we are going to talk about the estate tax and the danger that families face in simply ignoring the issue altogether. As you may already know, with the passage of tax reform in 2018, the federal estate tax exemption was increased to $11.18 million. What this means is that for your estate to be subject to the federal estate tax, it must first have a value of $11.18 million. You might be thinking, well that’s great, I have no chance of an estate tax issue unless I win the lottery.

Since 2001, there has been a number of changes to the estate tax. Listed below is a table that shows the changes:

 

Year

Exclusion Amount

Top Tax Rate

2001

$675,000

55%

2002

$1 million

50%

2003

$1 million

49%

2004

$1.5 million

48%

2005

$1.5 million

47%

2006

$2 million

46%

2007

$2 million

45%

2008

$2 million

45%

2009

$3.5 million

45%

2010

Repealed

 

2011

$5 million

35%

2012

$5.12 million

35%

2013

$5.25 million

40%

2014

$5.34 million

40%

2015

$5.43 million

40%

2016

$5.45 million

40%

2017

$5.49 million

40%

2018

$11.18 million

40%

 

As you can see, the federal estate tax has been adjusted nearly every year since 2001. However, the exemption amount has been rising over the next several years. Although, many attorneys will tell you that they do not know where the estate tax will be going in the coming years.
 

Let me share with you a story that occurs in the not so distant future that resulted in big problems for John and Jane Does with their estate planning.
 

John and Jane were age 35 and 36, and they have two young children. John and Jane had been speaking with friends, family, and neighbors, and knew that they needed to take care of their estate planning. After all, they owned their home, some assets, some life insurance, and had two children that needed to be provided for in the event of the unthinkable.
 

John and Jane met with an attorney who discussed many aspects with them about their planning including the estate tax. The attorney mentioned that the federal estate tax has increased to $11.18 million. However, given their assets and life insurance, they may need want to consider an Irrevocable Life Insurance Trust (ILIT) as part of their planning.
 

John and Jane each had a life insurance policy. John’s policy was $5 million, and Jane’s was $1 million. In addition, John and Jane had their home and other assets totaling about $500,000. The attorney explained that should the die, the life insurance proceeds, that would currently be payable to their children if they both died, would be included in their taxable estate. The attorney mentioned that right now, they are fine, but if the estate tax changed to pre-2011 levels, that they would have an estate tax issue.
 

The attorney discussed this ILIT and said that it owns the life insurance, so that this way, if John were to die, the $5 million death benefit would not be included in John’s estate. However, the attorney explained that there is a 3-year look back period, and if the law changes, they could be in a position that would subject their estate to an estate tax.
 

John and Jane recognized the concern, but felt it was a very low probability, and did not decide to pursue an ILIT, but instead established a Living Trust based estate plan.
 

Fast forward, 10 years later, it is 2028. In the news has been the exploding national debt which is now exceeding $35 trillion. In an effort to fix the country’s crippling debt issues, Congress has passed new tax reform that includes a change to the estate tax reducing the exemption to $1.5 million with a top tax rate of 50%.
 

John and Jane recently experienced the tragedy that John was diagnosed with cancer. Although the doctors have given him good odds, the family is still concerned about his treatment and whether or not he will survive. Knowing about the estate tax law change, the family goes back to their attorney and decides to establish an Irrevocable Life Insurance Trust due to the size of their estate.
 

John and Jane still have the $1 million and $5 million life insurance policies respectively, but their home and other assets have now increased to $750,000. The attorney explains the structure of the ILIT, but also again tells them about the 3-year look back provision.
 

The family understands and implements this strategy.
 

Unfortunately, the treatment of John’s cancer does not go well, and he passes away two years later. The result is that John’s $5 million life insurance policy is included in his taxable estate.
 

The result, John has a taxable estate of at least $4 million!
 

As I routinely tell families, I have no idea what is going to happen with the estate tax in the years ahead. However, the current state of our national debt indicate that the estate tax exemption will be reduced in the years ahead.
 

You do not want to be in a situation where the estate tax laws change, you suddenly have a taxable estate, and now you don’t have the time to complete the 3-year look back window to remove a life insurance policy from your taxable estate.
 

When it comes to estate planning, it is important to act early and speak with an attorney who has experience with these types of estate planning strategies.

If you are ready to put the perfect plan in place to protect you and your family, please give us a call. We are happy to sit down with you and your family to discuss your options so that we can create the perfect plan to protect your family now and in the future.

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Daniel A. Perry
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Focused on helping seniors, individuals with disabilities and small business owners make informed decisions.
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