The answer to this question has become a lot more complex since passage of the Economic Growth and Tax Relief Reconciliation Act (EGTR-RA) of 2001. Basically, the amount a decedent can leave estate tax free depends on the Applicable Exemption Amount that corresponds to the year of decedent's death. Assuming EGTRRA continues in its present form, the analysis breaks down to three time periods: 2002-2009; 2010; and post-2010.

2002-2009

For the period 2002-2009, the amount that can be passed estate tax free starts at $1,000,000 in the year 2002 and grows to $3,500,000 by the year 2009, as illustrated on the following chart:

An unlimited amount - over and above the Applicable Exemption Amount - can be passed to a surviving spouse (the "unlimited marital deduction"). Without proper planning, these two seemingly generous rules can offset each other. For example, if a decedent leaves all of his assets to his surviving spouse (as would be the case where spouses hold all of their , assets jointly), the decedent permanently forfeits his right to leave $1,000,000 (2002) estate tax free to individuals other than his or her surviving spouse.

If a couple's combined estates exceed the Applicable Exemption Amount, it is important that they plan together to fully utilize their respective Applicable Exemption Amounts. With proper planning, they may leave up to double the Applicable Exemption Amount ($2,000,000 in 2002) free of federal estate tax. To accomplish this result, and gain the full benefit of both spouses' Applicable Exemption Amount, each spouse must have a revocable living trust.

Once created, each trust must be "funded" (see Chapter 8). That is, the couple's assets must be re-titled into the name of their trusts - with an eye toward making them roughly equal in value. The diagram below illustrates the operation of the two-trust system. Each trust is funded with assets previously owned by the couple either individually or in joint name. During the lifetime of the spouses, the family and marital trusts are dormant and do not become operational until the death of the grantor.

Upon the death of the first spouse to die (the "husband" in the above example), the deceased spouse's trust divides into two separate trusts: the "family trust" and the "marital trust." According to .the terms of the typical revocable living trust, trust assets equal to the Applicable Exemption Amount ($1,000,000 in 2002) are first allocated to the family trust, with the balance (if any) allocated to the marital trust. No federal estate tax is due on the death of the husband, since the husband's Applicable Exemption Amount covers the family trust, and the marital trust qualifies for the unlimited marital deduction. No marital deduction is available if the surviving spouse is a non-U.S. citizen. It should be noted that the balance remaining in the marital trust upon the wife's subsequent death is included in the wife's estate for tax purposes. The marital trust, may, by its terms, permit the surviving spouse to designate the beneficiary of the balance of the marital trust at the surviving spouse's death (a "general power of appointment") or may not permit such designation ("QTIP" Trust, See Chapter 10).

The surviving spouse may never designate the beneficiary of the balance of the family trust, since such power would cause the family trust to be included in the estate of the surviving spouse. Such a result would defeat the purpose of creating the family trust; that is, to bypass the surviving spouse and utilize the Applicable Exemption Amount of the first spouse to die.

After the first spouse's death, income and principal from both the family trust and the marital trust are available to the surviving spouse to allow her to maintain the lifestyle she enjoyed while her husband was alive. Typically, amounts remaining in the marital trust at the time of the surviving spouse's death are paid over to the husband's family trust to be added to other family trust assets and thereafter allocated among the beneficiaries of the family trust. As noted above, amounts transferred to the marital trust qualify for the marital deduction as long as the surviving spouse has either a general power of appointment or the marital trust qualifies as a QTIP. In the event that the marital trust is drafted to contain a general power of appointment in the surviving spouse, the surviving spouse could in fact appoint her own beneficiaries to receive the amounts remaining in the marital trust at the time of her death. Power of appointment marital trusts provide that in the absence of a specific exercise of the power of appointment in the surviving spouse's Will, amounts remaining in the marital trust at the death of the surviving spouse will automatically be transferred to the family trust to be distributed according to the terms of the family trust.

The two-trust system described above allows couples to shelter up to $2 million (2002) from federal estate tax. Various planning techniques are available to estates that exceed $2 million. Irrevocable life, insurance trusts act to remove the full value of life insurance from the decedent's estate (see Chapter 15). Limited liability companies are proven vehicles for making lifetime gifts while allowing the donor to retain control over the gifted assets (see Chapter 16). Charitable Trusts allow for substantial income and estate tax savings for the charitably minded (see Chapter 18). Couples with a combined estate that is substantially below $1,000,000 should consider adopting a "joint" revocable living trust. Such trusts avoid probate and deliver all of the other non-tax benefits of revocable living trusts. Joint trusts become irrevocable only on the death of the surviving spouse and thus eliminate much of the administrative burdens of irrevocable trusts (see Chapter Seven: Lost and Found: Finding Self-Reliance After the Death of a Spouse, Collinwood Press, 2001).

Michigan converted to a "pick up" estate tax in 1993, effectively eliminating Michigan Inheritance tax. Now, the State of Michigan receives a portion of the federal estate tax that would have been paid the federal government if not for the state death tax credit available on the federal return (Form 706). EGTRRA phases out the state death tax credit by the year 2005. States like Michigan that adopted a pick up tax will either have to forego all inheritance revenues after 2004 or reinstate their old inheritance tax regimes. Thus, EGTRRA not only creates uncertainty at the federal level, but the state level as well.

The federal estate tax, when it applies, is rather severe. As with the federal income tax, the federal estate tax is graduated, with larger estates subject to a higher percentage of tax. As can be seen below, the federal estate tax can reach fifty (50%) percent. The first step in calculating the federal estate tax is to calculate the tentative tax. The decedent's unified credit from the Applicable Exemption Amount is then applied to offset the tax. The tentative tax is determined by applying the tax rates from the table on the next page to the decedent's taxable estate (see Chapter 2 for the method of determining taxable estate).

The unified rate schedule, with adjustments noted at the bottom of the schedule that reflect the phased-in reduction of the maximum transfer tax rates, applies to estates of decedents dying, and gifts made, before January 1, 2010. EGTRRA repealed the estate tax with respect to estates of decedents dying after December 31, 2009.

CALCULATING THE TAX

For example, if Harry died in 2002 with a taxable estate of $1,300,000, his tentative tax would be $469,800 ($448,300 plus 43% of the excess over $1,250,000). If Harry had not used any of his unified credit during his lifetime, his full $345,800 unified credit would be applied against his tentative tax ($469,800 - $345,800) leaving an actual federal estate tax of $124,000.
Had Harry died in 2002 with an estate of $1,000,000, his tentative tax would have been $345,800, exactly equal to the unified credit for 2002. The credit would exactly offset the tax due. For sake of simplicity, speakers and writers on the subject of estate planning often refer only to the Applicable Exclusion Amount ($1,000,000) and not the actual unified credit amount ($345,800).

2010

EGTRRA fully repeals the estate tax in the year 2010. If death occurs in 2010, no tax is due no matter what the size of the decedent's estate. Note, however, that the gift tax is not repealed. Apparently, Congress retained the gift tax to discourage the gifting of income-producing assets to family members in lower income tax brackets for income tax avoidance purposes.

2011 AND FORWARD

EGTRRA contains a sunset provision: changes contained in the act expire on December 31, 2010 unless Congress and the President extend the Act before that date.

If the sunset takes effect, all of EGTRRA's changes would be repealed; the law would revert to its pre-2002 status, and the Applicable Exemption Amount would return to $1,000,000.

Planning is difficult with the looming sunset provision. One cannot assume that the estate tax will disappear in 2010, especially considering how the world has changed since EGTRRA's passage.

Remember that the major impetus for the elimination of the estate tax in 2001 was the budget surplus that was predicted to last far into the future.

Today, the budget surplus, thriving economy and stock market have vanished, while domestic and military defense costs have skyrocketed. With a widening budget deficit, it is only be a matter of time before Congress revisits the tax code looking for revenue. Democrats and Republicans will undoubtedly propose different solutions, but changes in some form are inevitable.

From an estate planning perspective, the only prudent approach is to assume that the estate tax will be with us for a very long time to come, and individuals with estates in excess of $1,000,000 should continue to plan to minimize or eliminate estate tax.

QUALIFIED FAMILY OWNED BUSINESS INTEREST EXCLUSION

The 1997 Tax Act created the "Qualified Family Owned Business Interest Exclusion," ("QFOBI Exclusion"). The exclusion increases the total individual exclusion amount to $1.3 million and could potentially increase a married couple's total exclusion amount to $2.6 million, if an estate contains certain family owned business assets. The QFOBI exclusion - due to its unnecessary complexity - never delivered the tax relief hoped for, and under EGTRRA is repealed effective January 1, 2004.