Good question. Congress has elected to keep us in suspense.

www.youtube.com/watch?v=o_6CnlAwiPM

0% estate taxes in 2010 … for now, anyway. On January 1, the federal estate tax went away – at least for the time being and perhaps for all of 2010 as envisioned back in 2001. President Obama and Congressional leaders wanted the estate tax to stick around in 2010 at 2009 levels (estate taxes up to 45% with a $3.5 million exemption), but lawmakers were preoccupied with other matters.^1,2

Will Washington really give families million-dollar tax breaks? If no estate tax is imposed in 2010, it could mean a savings of millions for wealthy families. There is talk of bringing the tax back retroactively – after all, the federal government could really use the money. Yet the further we get from January 1, the more difficult reinstating the estate tax for 2010 may become.

As American Institute of Certified Public Accountants vice-president for taxation Tom Ochsenschlager told MarketWatch, “They’re still talking (in Congress) about making something retroactive, but at some point they can’t do that … is it even constitutional? There’s a real question about that.”

The unconstitutional argument goes like this: if Congress moves to retroactively apply the estate tax for 2010, an estate could take the mater to court and point out that Congress had all year to reinstate it but failed to do so.

That argument aside, some estate planners think Congress will get around to a retroactive measure – one that would put the 2009 estate tax levels back into place for 2010.

So, what taxes are in place now? Some taxes still apply to estates in 2010 even if the estate tax doesn’t. People who give away more than $1 million during their life still face federal gift taxes – though in 2010, they max out at 35% instead of 45%.³

Also, all assets with capital gains are to be taxed at 15% above a $1.3 million federal exemption when sold by heirs in 2010. The big news here is that heirs don’t get to use a step-up this year. When they compute the value of an inherited asset, they have to use the basis (the original price paid for the asset) instead of how much that asset was worth when the original owner died. (In addition to the $1.3 million exemption per estate just mentioned, there is another $3 million exemption available for assets inherited from a spouse.)³

What precautions may be wise this year? As a potential heir, you’ll want to document the cost basis of any assets you might receive in 2010. Good recordkeeping is in order.

Additionally, you may want to search a trust or a will for so-called formula clauses anchored by words such as “that portion”, “that amount” or “that fraction”, especially if the will or trust was created some years ago with the presumption of a constantly increasing federal estate tax exemption.

These formula clauses are fundamental to bypass trusts created to defend estate tax exemptions for a couple. However, these clauses assume that there is an estate tax. With no estate tax in place, there is the possibility (depending on how the formula clause is worded) that a deceased spouse’s assets would not be inherited by the surviving spouse, but instead go directly into the family trust – not the most useful result for the surviving spouse.³

What will 2011 bring? Well – if there are no changes – the estate tax and the generation-skipping tax would come back in 2011. Only the first $1 million of an estate would be exempt from estate taxes. Assets above the exemption would be hit with a 55% federal penalty.³ However, the Obama administration had talked of keeping the 2009 estate tax levels in place for 2010 and beyond, which would be better than returning to the pre-EGGTRA levels in 2011.

An estate planning option more families ought to know about.

www.youtube.com/watch?v=28Zf4B0uROA

You may think of life insurance in very simple terms: you buy a policy so that your loved ones will have some financial assistance when you die. But if you have assets of $1 million or more, you should view life insurance as a tool – kind of a Swiss army knife, in fact. Life insurance has many potential uses in estate planning, and a life insurance trust can certainly help a family.

What does a life insurance trust do? It enables you and your family to do three things in particular. One, it provides you, your spouse and your heirs with life insurance coverage after it is implemented. Two, it allows a trustee to distribute death benefits from a life insurance policy as that trustee sees fit. Three, it gives you the chance to reduce your estate taxes.

When you create a life insurance trust, you are creating an entity (the trust) to buy life insurance policies for you and your loved ones. You don’t own the policies, the trust does. So the insurance proceeds go into the trust when someone passes away. Because the trust owns the insurance policies instead of a person, the insurance proceeds aren’t subject to probate, income taxes or estate taxes. The trustee can distribute those proceeds to one or more parties as stipulated in the language of the trust. Also, if your estate ends up really large, the trust can buy additional life insurance to provide additional cash to pay additional estate taxes.

Sometimes these trusts establish investment policies for life insurance proceeds, and even timelines for who receives what when (families may want to delay an heir from legally receiving an inheritance until age 18 or 21, for example).

Why not just have someone else own my insurance policy? That scenario can lead to major financial and familial headaches. If that person dies before you die, the cash value of the policy will be included in their taxable estate. So the heirs (and relatives) of that person will have higher estate taxes to pay as a result. Also, if you do this, you surrender control of your policy; the loved one you trust could end up naming another beneficiary or even cashing your policy out.

A decision for life. Almost all life insurance trusts are irrevocable trusts. That is, they are legally “set in stone” once created, unlike a revocable trust which can be amended or revoked after creation. You can make these trusts revocable, but if you do, you lose the tax benefit: the insurance proceeds will be included in your taxable estate when you die, which could increase the estate tax bill for your heirs. However, some irrevocable life insurance trusts purchase survivorship life insurance in a profit sharing plan to permit the ability to change beneficiaries.

If you’d like to know more about life insurance trusts or the potentially significant changes in estate taxes over the next few years, talk me by calling 800-990-2734 or by sending me an email at Pete@PeteMitchellinc.com.

Who should inherit your IRA or 401(k)? See that they do.

www.youtube.com/watch?v=M4SY07wSdSk

Here’s a simple financial question: who is the beneficiary of your IRA? How about your 401(k), life insurance policy, or annuity?

You may be able to answer such a question quickly and easily. Or you may be saying, “You know … I’m not totally sure.” Whatever your answer, it is smart to periodically review your beneficiary designations.

Your choices may need to change with the times. When did you open your first IRA? When did you buy your life insurance policy? Was it back in the Eighties? Are you still living in the same home and working at the same job as you did back then? Have your priorities changed a bit – perhaps more than a bit?

While your beneficiary choices may seem obvious and rock-solid when you initially make them, time has a way of altering things. In a stretch of five or ten years, some major changes can occur in your life – and they may warrant changes in your beneficiary decisions.

In fact, you might want to review them annually. Here’s why: companies frequently change custodians when it comes to retirement plans and insurance policies. When a new custodian comes on board, a beneficiary designation can get lost in the paper shuffle. (It has happened.) If you don’t have a designated beneficiary on your 401(k), the assets may go to the “default” beneficiary when you pass away, which might throw a wrench into your estate planning.

How your choices affect your loved ones. The beneficiary of your IRA, annuity, 401(k) or life insurance policy may be your spouse, your child, maybe another loved one or maybe even an institution. Naming a beneficiary helps to keep these assets out of probate when you pass away.

Many people do not realize that beneficiary designations take priority over bequests made in a will or living trust. For example, if you long ago named a son or daughter who is now estranged from you as the beneficiary of your life insurance policy, he or she will receive the death benefit when you die, regardless of what your will states.¹

You may have even chosen the “smartest financial mind” in your family as your beneficiary, thinking that he or she has the knowledge to carry out your financial wishes in the event of your death. But what if this person passes away before you do? What if you change your mind about the way you want your assets distributed, and are unable to communicate your intentions in time? And what if he or she inherits tax problems as a result of receiving your assets? (See below.)

How your choices affect your estate. Virtually any inheritance carries a tax consequence. (Of course, through careful estate planning, you can try to defer or even eliminate that consequence.)

If you are simply naming your spouse as your beneficiary, the tax consequences are less thorny. Assets you inherit from your spouse aren’t subject to estate tax, as long as you are a U.S. citizen.² For example, a spouse can roll assets inherited from a 401(k) plan into an IRA without incurring taxes on the wealth transfer.³

When the beneficiary isn’t your spouse, things get a little more complicated … for your estate, and for your beneficiary’s estate. If you name, for example, your son or your sister as the beneficiary of your retirement plan assets, the amount of those assets will be included in the value of your taxable estate. (This might mean a higher estate tax bill for your heirs.) And the problem will persist: when your non-spouse beneficiary inherits those retirement plan assets, those assets become part of his or her taxable estate, and his or her heirs might face higher estate taxes. Your non-spouse heir might also have to take required income distributions from that retirement plan someday, and pay the required taxes on that income.⁴

If you designate a charity or other 501(c)(3) non-profit organization as a beneficiary, the assets involved can pass to the charity without being taxed, and your estate can qualify for a charitable deduction.⁴

Are your beneficiary designations up to date? Don’t assume. Don’t guess. Make sure your assets are set to transfer to the people or institutions you prefer. Let’s check up and make sure your beneficiary choices make sense for the future. Just give me a call or send me an e-mail – I’m happy to help you.

Citations.

¹ seattlepi.nwsource.com/lifestyle/356213_consumer25.html          [4/24/08]

² smartmoney.com/taxmatters/index.cfm?Story=20020830              [9/29/00]

³ online.wsj.com/public/article/SB119948578270968559.html?mod=yahoo_free         [1/5/08]

⁴ news.morningstar.com/articlenet/article.aspx?id=212411           [11/6/07]

⁵ investmentnews.com/apps/pbcs.dll/article?AID=/20080331/REG/872112904/1037 [3/31/08]

This material was prepared by Peter Montoya Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information should not be construed as investment, tax or legal advice.