In my experience, most people want the disposition of their property at their death to be quite simple. They may have a favorite charity or two, or a special nephew, niece or grandchild to provide for, but by and large they want to leave their estate to their surviving spouse, or alternatively, to their children. Simplicity slips away, however, with the arrival of the tax man.
With some exceptions and exemptions, all estates in Maine are taxed by both the federal government and the state. Combined, these taxes can gobble up nearly half of some larger estates. The taxes apply to virtually all assets owned by a decedent, including real estate, personal property, investments, bank accounts and life insurance proceeds. There are credits against the tax that effectively exempt portions of estates from taxation. As of this writing, estates under $5 million are effectively exempt from the federal tax, and estates under $1 million (probably soon to be $2 million) are effectively exempt from the Maine tax. Those amounts can be transferred to heirs tax-free. Once the total estate exceeds those numbers, the taxes apply, and they’re not cheap.
There is a 100 percent marital deduction for gifts and bequests between spouses, allowing unlimited, tax-free transfers between husband and wife. The problem arises on the death of the surviving spouse. That’s when the taxes come due, and they are payable in cash within nine months of the date of death.
Life insurance can be purchased by, or transferred to the trustee of, an irrevocable trust, with an independent trustee, for the benefit of a surviving spouse and children. Because the insured doesn’t own the policy at the time of death, the policy proceeds will not be included in their taxable estate. A life insurance trust using term insurance policies is usually recommended. Policies with a cash value may raise gift tax issues, and irrevocable means just that: You can’t change your mind or the significant terms of the trust later. You’re stuck with what you did. With term insurance, if it turns out you no longer want to maintain the trust, or no longer need the policy, you can simply stop paying the premiums and the policy will be canceled.
A will can be drafted containing a trust designed to hold assets with a value that will maximize tax savings while still adequately providing for the surviving spouse. An independent trustee could pay all of the trust income to the spouse, and have the discretion to invade principal for his or her health, maintenance and support needs. Because the trust assets are legally owned by the trustee, instead of the surviving spouse, on the death of the spouse the trust assets would not be included in his or her estate. They would pass to the beneficiaries free of estate taxes regardless of their value.
The problem is you don’t know what size your estate will be in the future, and you don’t know what the estate tax exemptions will be. In the last few years, there have been dramatic changes in both the economy and the tax laws. The exemptions are under almost constant review and negotiation in both state legislatures and Congress. To provide more flexibility, instead of an outright transfer into the trust, you could provide that it will only be funded with assets the survivor has disclaimed. This provides an opportunity for a second look at the situation. If it appears that the survivor will have an estate tax problem, he or she can disclaim whatever amount is necessary to avoid or minimize the tax. This amount would go into the trust and would not be included in his or her taxable estate because the survivor doesn’t own the trust assets. The trustee owns them for the benefit of the survivor. If it appears that there will be no tax problem, they won’t have to disclaim anything, and we’re back to our “all to each other or the children” will.
This approach is only one of many possibilities for achieving estate planning goals. There are living trusts, marital trusts, charitable trusts, and other options. The above example seems to be one reasonably simple and effective way to achieve a result that many people want.
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