LIFETIME & ESTATE PLANNING CONCEPTS

For planning purposes, assets are classified as follows: jointly held with rights of survivorship; contract assets (life insurance, IRA’s, annuities) and probate assets. For estate tax purposes all assets are included in a deceased person’s estate if they owned at the time of his/her death or the deceased person had the use or enjoyment of such assets at the time of his/her death. However, assets that are not jointly held with rights of survivorship or contract assets are probate assets. The terms of your Will only pertain to probate assets and how such assets are to be distributed upon your death.

For the year 2010 the federal estate tax was repealed for one year. As of January 1, 2011, the federal estate tax was reinstated, resulting in an “applicable exclusion amount” of $5,000,000 for the years 2011 and 2012. On January 1, 2013, the $5,000,000 exclusion amount was extended permanently.

If the total assets less deductions and expenses of your estate do not exceed the “applicable exclusion amount”, there will be no federal estate tax.

The “applicable exclusion amount” also applies for gift tax purposes, which means that if during your lifetime you made taxable gifts, the amount of your taxable gifts will reduce the “applicable exclusion amount” that will be available for federal estate tax purposes. As of January 1, 2011, each person is allowed to make annual non-taxable gifts, if the amount of the gift to each person does not exceed $13,000 ($26,000 for couples), and this does not reduce the “applicable exclusion amount.”

In addition to the “applicable exclusion amount”, there is a marital deduction which is unlimited. One spouse can leave their entire estate to the other spouse and there will be no estate tax when the first spouse dies, however, upon the death of the second spouse, if the net taxable federal estate is in excess of the “applicable exclusion amount”, there will be federal estate tax on the excess provided the second spouse does not remarry (new spouse) and does not leave his/her estate to their new spouse.

There is a planning concept known as an “applicable exclusion amount” trust whereby upon the death of the first spouse, assets equal to the “applicable exclusion amount” are transferred to a trust, and the income of the trust is used for the support and maintenance of the surviving spouse for their lifetime and upon their death, the assets in the trust will be distributed to your children, if you so desire. The purpose of the “applicable exclusion amount” trust is that the value of the trust as of the date of death of the surviving spouse will not be included in the surviving spouse’s estate, therefore not subject to estate tax.

There is another planning concept known as a disclaimer trust which is similar in intent and purpose as the “applicable exclusion amount” trust. For the “applicable exclusion amount” trust, the assets must be placed in trust upon the death of the first spouse. The disclaimer trust allows the surviving spouse nine months after the death of the first spouse to determine if they want to disclaim and not receive assets from the deceased spouse’s estate outright. If the surviving spouse disclaims, the value of the assets disclaimed (usually no more than the “applicable exclusion amount”) will be placed in trust. The disclaimer trust allows the surviving spouse to determine his/her financial needs upon the death of the first spouse. Upon the death of the surviving spouse, the value of the trust will not be included in his/her estate. In essence, the disclaimer trust gives the surviving spouse another bite at the apple to determine, within nine months after the death of the first spouse, what assets he/she does not need outright for his/her financial support, and the assets disclaimed will be placed in trust for the benefit of the surviving spouse. One word of caution, the surviving spouse cannot use or receive any benefit from any assets disclaimed. If he/she does, such assets cannot be effectively disclaimed by the surviving spouse.

The “applicable exclusion amount” trust or the disclaimer trust would have to have a Trustee. You can name whomever you choose. However, if possible, it is advisable not to have your child as the Trustee because such child will be the remainderman of that trust which means upon the death of the surviving spouse, whatever assets remain in the trust go to the children. This may pose a conflict between the children and the surviving spouse because the children may want to invest the assets in growth securities which may not generate a lot of income, wherein the surviving spouse would like to put the assets in securities that generate a lot of income because the income will be utilized for the support and maintenance of the surviving spouse. It is better that the Trustee not be the surviving spouse because if there are no objective standards for trust invasion, or if the surviving spouse has unlimited trust powers, the trust will be included in the surviving spouse’s estate. I suggest that whomever you name as a Trustee, should be either a person or financial institution with knowledge of how to manage and invest funds.

If you provide for either an “applicable exclusion amount” trust or a disclaimer trust in your Will, upon the death of the surviving spouse, the amount placed in Trust will not be included in the surviving spouse’s estate, saving federal estate taxes depending upon the fair market value of the assets that the surviving spouse owned at the time of their death and what is the applicable exclusion amount at that time.

In addition to the “applicable exclusion amount” and disclaimer trusts, there is another planning concept known as a QTIP Trust (Qualified Terminable Interest Property), whereby the surviving spouse will receive the income from the trust at least annually with the discretionary power of the Trustee to invade the principal of the trust for the support, education and maintenance of the surviving spouse. Upon the death of the surviving spouse, the fair market value of the QTIP trust at the date of death of the surviving spouse will be included in the surviving spouse’s estate. If the value of all of the assets of the surviving spouse, including the value of this trust, exceeds the then applicable exclusion amount, the surviving spouse will be subject to federal estate tax. The Trustee, by the terms of the QTIP Trust, will be directed, unless the Will of the surviving spouse provides otherwise, to pay any estate taxes owed by the surviving spouse’s estate because of the inclusion of the value of this trust in the surviving spouse’s estate. The surviving spouse has no control over this trust. The terms of the trust are governed by the Will of the first spouse who died and they can provide that the principal of the trust upon the death of the surviving spouse goes to whomever he/she choose.

Your life insurance will be included in your estate for federal estate tax purposes as long as you possess “incidence of ownership” although life insurance is exempt from New Jersey estate tax if it is payable to a named beneficiary other than your estate. “Incidence of ownership” means either that the insured was the owner of that insurance policy at the time of his/her death or had the right to use the policy or change the beneficiary of his/her insurance policy. Depending upon the amount of your life insurance, you may want to set up a life insurance trust whereby such insurance policy would not be subject to estate tax.

Depending upon the value of your estate some or all of the above concepts may or may not be applicable.

In addition to a Will, you will need a Power of Attorney whereby you appoint another person as your attorney-in-fact (agent) to act for you. A Power of Attorney may be limited to one specific action, a “special” Power of Attorney, or it may authorize the agent to perform virtually any kind of financial transaction, a “general” Power of Attorney. In addition, a Power of Attorney may be classified as “springing” or “durable.” A springing Power of Attorney empowers the agent to act only upon the incapacity of a person, while a durable Power of Attorney becomes effective immediately upon executing the instrument and remains in effect despite a person’s subsequent incapacity. However, a Power of Attorney terminates upon death of the person who issued same.

You may also want to have an Advanced Directive for Health Care (Living Will) which concerns medical decisions if you are brain dead and being kept alive by artificial means. The Living Will appoints a health care representative to withhold these artificial means of keeping you alive.

In addition to the Federal Estate and Gift Tax Law, New Jersey has two taxes that may apply upon a person’s death, the New Jersey Transfer Inheritance Tax and New Jersey Estate Tax. There will be no New Jersey Transfer Inheritance Tax if the estate is being distributed to Class “A” beneficiaries (spouse, children, issue of children, parents and grandparents of Decedent). A New Jersey Estate Tax Return will have to be filed if the Decedent’s gross estate exceeds $675,000, and if the taxable estate is more than $675,000, there will be New Jersey Estate Tax owed even though there may be no New Jersey Transfer Inheritance Tax due.

The concepts expressed herein are based upon the current Federal Estate and Gift Tax Laws and New Jersey Estate and Transfer Inheritance Tax Laws as of January 1, 2011 and are for informational purposes only and not to be relied upon without the express written consent of A. Schancupp & Associates, L.L.C.