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Minimization of Estate Taxes

There are many reasons why people have Living Trusts. Mostly people have Living Trusts to avoid probate, to control distribution of their assets to their minor children and to avoid conservatorships in the event of incapacity. For some, whose estates exceed the non-taxable limit set by Congress, proper use of the Living Trust will also significantly reduce estate taxes.

Many people are surprised when they learn that there even is an estate tax i.e. a tax, which is imposed on the value of your estate upon your death. Congress has, however, long allowed there to be a certain size of an estate, which is exempt from estate taxes.

So what is the Estate Tax Exemption amount, and how much is the rate of estate tax that Congress decided upon? In general, the Estate Tax Exemption for 2017 is $5,490,000, which is indexed for inflation, and the current estate tax rate imposed on any excess over the Estate Tax Exemption is 40%. The calculation of estate tax is more involved but, in general, that's where we are with regard to the estate tax.

As a brief background, under the law in effect in 2010, the Estate Tax Exemption was $5,000,000. That law was set to expire on December 31, 2012 at which point the Estate Tax Exemption was set to go back down to $1,000,000 with a rate of 55% on anything over that $1,000,000. This was a huge concern for many people whose taxable estates were over $1,000,000 but less than $5,000,000. Fortunately, in the early days of 2013, the American Taxpayer Relief Act was passed and that law made the $5,000,000 Estate Tax Exemption "permanent" (i.e. until Congress decides to change it).

Since it was permanent, the issue of inflation needed to be addressed. The solution was to "index" the $5,000,000 Estate Tax Exemption, meaning that it will be adjusted for inflation each year. For example, in 2012, the Estate Tax Exemption was $5,120,000, and for decedent's dying in 2017, the Estate Tax Exemption has been inflation adjusted to $5,490,000. Therefore, in general, if a taxable estate of a person dying in 2017 exceeds $5,490,000, then there will be an estate tax imposed at the rate of 40% on that excess.

"Portability"

Also under the American Taxpayer Relief Act of 2012, the concept of "portability" of the Estate Tax Exemption was made law. Essentially what this means is that the surviving spouse can use the "unused" portion of the first spouse to die's Estate Tax Exemption. The effect of this is to make it even more unlikely that a couple will have to pay estate taxes.

With the rise in the Estate Tax Exemption to $5,000,000 indexed for inflation for every individual, most people will not have to pay any estate tax simply because their estate is under the Estate Tax Exemption amount ($5,490,000 in 2017). "Portability" essentially doubles this for married people. For example, if a husband dies in 2017 and uses only $3,000,000 of his $5,490,000 Estate Tax Exemption, then the surviving spouse wife now has her $5,490,000 (indexed for inflation), plus the "unused" portion of the husband's Estate Tax Exemption, which in my example is $2,490,000 ie. $5,490,000 available - $3,000,000 used by the predeceased husband's estate. So, in total, the surviving spouse wife now has $7,980,000 ($5,490,000 of the surviving spouse + $2,490,000 unused by the predeceased husband and "ported" to the surviving spouse's estate) as an Estate Tax Exemption.

With married couples now able to obtain the estate tax benefits by using "portability", the issue arises as to whether it is still necessary for couples with an estate below the Estate Tax Exemption amount to have a Living Trust. The answer is yes - even if there are no estate taxes to be paid, there remain many significant reasons to still have a Living Trust including (1) avoidance of Probate; and (2) general estate planning for your family so that your estate goes to your beneficiaries on the terms you wish and will be properly managed by your chosen successor trustees to implement your estate plan.

Remember, a properly funded Living Trust avoids Probate, and this is the primary reason I estimate that perhaps 80% or more of people use a Living Trust. It's important to understand how the Probate Fee calculation works.

EVEN IF THERE ARE NO ESTATE TAXES (FEDERAL LAW), THERE MAY BE VERY HIGH PROBATE FEES (CALIFORNIA LAW) WITHOUT A PROPERLY FUNDED LIVING TRUST.

See Probate Fees under the Education Section of this website and calculate what the Probate Fees would be on your estate - you'll likely be surprised at how high Probate Fees can be.

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