Estate Planning 101 – Part 2

The third full week in October has been designated as National Estate Planning Awareness Week. Estate planning is a vital component of every financial plan, regardless of the size of the estate. Unfortunately, it’s also an area that is commonly overlooked. This often results in wasted dollars and emotional hardship that could otherwise be minimized with proper advance planning and action.

Be sure to check out Estate Planning 101 – Part 1

What are your goals and objectives?

Your goals and objectives are personal, but you can’t formulate a successful plan without a clear and precise understanding of what they are. They can be based on your particular circumstances and the factors that may affect your estate, as discussed earlier, but your feelings and desires are just as important. The following are some goals and objectives you might consider:

  • Provide financial security for your family
  • Ensure that your property is preserved and passed on to your beneficiaries
  • Avoid disputes among family members, business owners, or with third parties (such as the IRS)
  • Provide for your children’s or grandchildren’s education
  • Provide for your favorite charity
  • Maintain control over or ensure the competent management of your property in case of incapacity
  • Minimize estate taxes and other costs
  • Avoid probate
  • Provide adequate liquidity for the settlement of your estate
  • Transfer ownership of your business to your beneficiaries

What are estate planning strategies?

An estate planning strategy is any method that facilitates the distribution of your assets and the settlement of your estate according to your wishes. There are several estate planning strategies available to you.

Intestate succession

Intestate succession is a strategy by default and is a means of transferring your property to your heirs if you have failed to make other plans such as a will or trust. State law controls how and to whom your property is distributed, who administers your estate, and who takes care of your minor children. Without directions, your opinions and feelings are not considered. Indeed, one of your primary goals in planning your estate may be to avoid intestate succession.

Last will and testament

A will is a legal document that lets you state how you want your property distributed after you die, who shall administer your estate, and who will care for your minor children. This is probably the most important tool available to you. Anyone with property or minor children should have a will.

Will substitutes

A will substitute, for example, Totten Trust and payable on death bank accounts, allows you to designate a beneficiary of certain property that will automatically pass to that beneficiary after you die and avoids passing through probate.


A trust is a separate legal entity that holds your assets that are then used for the benefit of one or more people (e.g., you, your spouse, or your children). There are different types of trusts, each serving a different purpose, and include marital trusts and charitable trusts. You will need an attorney to create a trust.

Joint ownership

Joint ownership is holding property in concert with one or more persons or entities. There are different types of joint ownership, such as tenancy in common and community property, each with different legal definitions, requirements, and consequences.

Life insurance

Life insurance is a contract under which proceeds are paid to a designated beneficiary at your death. Life insurance plays a part in most estate plans.


A gift is a transfer of property, not a bona fide sale, that you make during your life to family, friends, or charity. Making gifts can be personally gratifying as well as an effective estate planning tool.

Tax exclusions, deductions, and credits

There are several important estate planning tools you can use that are offered by the federal government. These include the annual gift tax exclusion, the applicable exclusion amount, the unlimited marital deduction, split gifts, and the charitable deduction.

What is estate tax?

As the old saying goes, you can’t cheat death or taxes. In fact, you might still owe taxes after you die! One of these taxes is the federal estate tax. Generally, this is a tax that may be imposed on property owned by you (or deemed to be owned by you) at the time of your death.

Any U.S. citizen who leaves an estate (plus adjusted taxable gifts) in excess of the gift and estate tax exemption equivalent amount ($5,250,000 in 2013, $5,120,000 in 2012) may be subject to estate tax.

Estimating and planning for estate tax may be important to you because this could be one of the largest expenses your estate may have to pay. It also means that a significant part of your estate may go to the government and not to your beneficiaries.

Estate tax may be imposed on all U.S. citizens and/or residents. If you are a nonresident alien who owns property in the United States, your estate may be subject to estate tax; however, certain adjustments and requirements will apply. Although estimating estate tax can be complex, don’t be overwhelmed. If you proceed step by step, you can do it. Estimating estate tax is an important step in formulating and implementing a successful master estate plan. The peace of mind that comes with implementing a successful master estate plan should be worth your time and trouble.

Caution: Transfers of property you make to a person who is more than one generation below you (e.g., a grandchild or great-nephew) may also be subject to the federal generation-skipping transfer (GST) tax.

Caution: Some states also impose their own death taxes and GST tax. State death tax rates vary from state to state but are generally lower than the federal estate tax rates. However, states often will impose death taxes on estates of lesser value than the federal government. To avoid double taxation, a deduction is allowed for certain state death taxes you pay.

How does the unified tax system work?

Before 1976 (when Congress unified estate and gift taxes), gifts made during life (taxable gifts) were reported–and any gift tax owed was paid–on an annual basis. After death, estate tax was imposed only on property owned at death (gross estate).

Since 1976, generally, taxable gifts are still reported–and any gift tax owed is paid–annually (generally, you must file a gift tax return and pay gift tax due, if any, by April 15 of the year following the year in which you make a taxable gift). But upon death, all post-1976 taxable gifts are added to your taxable estate for estate tax calculation purposes, even though a gift tax return may already be filed and a gift tax paid (post-1976 gift tax paid is subtracted from the estate tax owed). Congress unified the gift tax and estate tax systems so that: (1) you can’t avoid estate tax by giving your wealth away before you die, and (2) you pay tax on the cumulative amount of wealth you give away (this pushes your estate into a higher tax bracket).

How does estate tax work?

Estate tax may be imposed on your taxable estate. The taxable estate is your gross estate (the value of your property when you die) reduced by the qualified conservation easement exclusion and various deductions.

Your cumulative taxable transfers are calculated by adding adjustable taxable gifts you made during life to your taxable estate. A tentative tax is calculated on your cumulative taxable transfers, as well as on your adjusted taxable gifts. The tax is calculated under the Unified Tax Rate Schedule, which is graduated; the larger the value of your cumulative transfers, the greater the tax rate (much like your income tax). A tentative estate tax is calculated by subtracting the gift tax on adjustable taxable gifts from the estate tax on cumulative taxable transfers.

Credits are subtracted from the tentative estate tax, resulting in the estate tax that is owed. The maximum estate tax rate in effect is 40 percent (in 2013, 35 percent in 2012).

Tip: If you have not made taxable gifts during your lifetime, there is a shortcut that can be used to estimate what your estate tax would be if you were to die in 2013. Simply subtract the applicable exclusion amount from the taxable estate, and multiply this amount by 40 percent. For example, estate tax on a $6,250,000 taxable estate for a decedent dying in 2013 would be $400,000 [$6,250,000 taxable estate minus $5,250,000 applicable exclusion amount equals $1,000,000; multiplied by the 40 percent top tax rate equals $400,000].

Caution: In general, estate tax should not be estimated by subtracting the applicable exclusion amount from the taxable estate, and then calculating tax on this amount from the gift and estate tax table with brackets. This will generally underestimate the amount of tax.

How is estate tax calculated?

Calculating estate tax is similar to calculating income tax. It is basically a four-step process.

1. Determine what is taxable

The first step in estimating estate tax is to determine what is subject to tax. This includes property owned by you (or deemed to be owned by you) at the time of your death (the gross estate).
Gross estate

Identify taxable property. List all your property and property interests–of any description, wherever located–at the time of your death. A word of caution: What you do not ordinarily think of as being your property may be considered your property by the IRS for estate tax purposes. This includes property that passes through probate and property inherited directly by joint owners or beneficiaries. Generally, your property includes:

  • Real estate
  • Personal property (e.g., cash, insurance proceeds, cars, furniture, jewelry, art objects)
  • Intangible property (e.g., copyrights, patents, stocks, bonds, notes)

Put a value on what you have identified. Assign a value to each property item you have identified. Generally, this is the fair market value (FMV) on the valuation date, though other valuation methods may apply. Simply stated, FMV means the price at which property would sell for on the open market. The valuation date is either the date of death or, if elected by your personal representative, six months after the date of your death.

Example(s): At the time of his death, Adam owned his own home with a FMV of $200,000, furnishings and appliances with a FMV of $25,000, and a car with a FMV of $5,000. He also had $20,000 in his bank account. Adam’s gross estate is $250,000 ($200,000 plus $25,000 plus $5,000 plus $20,000).

2. Determine what isn’t taxed

The second step in the estate tax calculation is to determine what isn’t taxed. Certain amounts are excluded from the gross estate and deductions are allowed to be subtracted from your gross estate. The result is your taxable estate.

The following exclusions are allowed:

  • Qualified conservation easement exclusion: A limited amount of the value of land subject to a qualified conservation easement can be excluded from your gross estate.
  • Social Security benefits: Any benefits payable to your heirs under the Social Security system are excluded from your gross estate (unlike some life insurance or retirement plan benefits).
  • Workers’ compensation death benefits: Any benefits payable to your heirs under your state’s workers’ compensation law are excluded from your gross estate.

Technical Note: While the applicable exclusion amount (or basic exclusion amount; sometimes referred to as an exemption) indicates the amount of property that can be sheltered from federal gift or estate tax by the unified credit, the applicable exclusion amount is not actually an exclusion (or exemption). So do not reduce the gross estate by the applicable exclusion amount. Instead, the unified credit is subtracted below as a credit against tax.


The following deductions are allowed:

  • Expenses: Certain expenses incurred by your estate can be deducted from your gross estate. These expenses include:
    • Funeral expense
    • Administration expense (e.g., executor’s or administrator’s fees, court costs, attorney’s fees, appraiser’s fees)
    • Certain debts of the decedent
    • Certain taxes
    • Certain claims against your estate
    • Casualty losses suffered during the administration of your estate
  • Unlimited marital deduction: The unlimited marital deduction is one of the most significant deductions allowed. It lets you deduct the value of property you leave to your spouse from your gross estate. Although this deduction is unlimited, only certain property interests qualify, and certain conditions and requirements must be satisfied.

Tip: If your spouse is not a U.S. citizen, the marital deduction is generally not available unless you use a qualified domestic trust (QDOT).

  • Charitable deduction: The entire value of property you leave to charity is deductible from your gross estate. The gift must be to a qualifying organization and must be for a public purpose. Gifts to individuals, no matter how needy, do not qualify. Certain conditions must be met to qualify for this deduction, but the amount is not limited as it is with the income tax deduction.
  • State death tax deduction: State inheritance or estate taxes (collectively referred to as state death taxes) paid are deductible from the gross estate. Generally, the deduction can be claimed only if such taxes are paid within four years after the federal estate tax return has been filed.

As noted above, certain amounts are excluded from, and deductions are subtracted from, your gross estate. The result is your taxable estate.

3. Calculate tentative estate tax

The third step is calculate the tentative estate tax. For this purpose, the taxable estate is added to your adjusted taxable gifts, resulting in your cumulative taxable transfers.

Generally, adjusted taxable gifts are gifts made after 1976 that are not “qualified transfers” for educational or medical purposes or transfers that qualify for the annual gift tax exclusion, marital deduction, or charitable deduction. Generally, the value of a gift is the FMV of the property on the date the gift is made.

A tentative tax is calculated on your cumulative taxable transfers, as well as on your adjusted taxable gifts. The tax is calculated under the Unified Tax Rate Schedule for gift tax and estate tax, which is graduated. A tentative estate tax is calculated by subtracting the gift tax on adjustable taxable gifts from the estate tax on cumulative taxable transfers. [The gift tax on adjustable taxable gifts is calculated as reduced by the unified credit available in the year of any gift.]

4. Deduct credits from your tentative estate tax

Once your tentative estate tax has been calculated, there are credits available to apply against the tax.

  • Unified credit (applicable exclusion amount): The unified credit ($2,045,800 in 2013) allows you to pass an amount referred to as the basic exclusion amount (formerly known as the applicable exclusion amount) free from gift and estate tax. This lifetime exclusion (which is sometimes referred to as an exemption) effectively exempts $5,250,000 from gift tax and estate tax in 2013. For 2011 and later years, the exclusion amount is portable, that is, any exemption that is unused by the first spouse to die may be used by the surviving spouse for gift tax and estate tax. [Technically, the Internal Revenue Code refers to the portable unused exemption as the deceased spousal unused exclusion amount (DSUEA).]
  • Credit for gift taxes paid: You are allowed to deduct the gift tax paid on taxable gifts you included in your gross estate if the gift was made before 1977.
  • Foreign death tax credit: Like the state death tax credit, the foreign death tax credit prevents double taxation. This credit is allowed for death taxes paid to a foreign country or U.S. possession on property included in your gross estate and situated in that country or possession.
  • Credit for federal estate tax on prior transfers: If your gross estate includes property that was transferred to you by will, gift, or inheritance, and on which estate tax has already been paid, you may be entitled to a credit.

This is what your calculation should finally look like:

Gross Estate
=Taxable Estate
+Adjusted Taxable Gifts
=Cumulative Taxable Transfers
Tax on Cumulative Taxable Transfers
Tax on Adjusted Taxable Gifts
=Tentative Estate Tax
=Estate Tax Owed

What else should you know about estate tax?

Your personal representative is responsible for filing your estate tax return and paying estate tax owed, if any. Your estate tax return and payment of estate tax is due within 9 months after your death. An estate will be allowed an automatic 6-month extension of time beyond the prescribed 9 months if Form 4768 is filed on or before the due date for filing Form 706. If an estate does not file for an automatic 6-month extension, an extension of up to 12 months can be obtained by showing reasonable cause. The IRS doesn’t define reasonable cause, but uses its own discretion to determine whether to grant or deny a request for an extension. The IRS may grant a series of extensions running as long as 10 years.

If you’re a business owner, under Section 6166, your personal representative may be able to defer the estate tax owed on your business interest.

If your estate owes tax, it must be paid before your beneficiaries can receive what you have left them. The IRS will have a lien against your estate and has the ability to seize or levy the estate property if the tax is not paid when due.

Tip: Making special provisions in your will for paying estate tax will ensure that your beneficiaries get what you intend for them to receive.


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