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Since 1976 the federal government has had a unified estate and gift tax. Generally, under this system each individual gets a tax credit which can be used to shelter a certain amount of gifts made either during life (in which case the credit is applied against the gift tax) or at death (in which case the credit is applied against the estate tax). As of 2000, the cumulative amount that can be transferred free of tax through the use of this unified credit is $675,000, but this amount is scheduled to increase over the next few years (see chart on next page). Once an individual’s credit is used up, subsequent transfers (whether made during life or at death) are taxed at progressive rates beginning at 37% and rising to 55% (on total transfers valued at over $3 million). Estates valued at over $10 million are subject to an additional surcharge.

Techniques for Reducing the Tax Burden
With careful planning, most people can significantly reduce the burden of the federal estate and gift taxes. The three most common techniques for accomplishing this goal, discussed below, use the annual gift tax exclusion, the unlimited marital deduction and unified credit trusts.

Annual Gifts
An individual can give up to $10,000 per recipient per year in gifts without incurring a federal (or Connecticut) gift tax. For example, a parent with four children can give $10,000 to each children — $40,000 in total gifts — without triggering any gift tax. Married couples who consent to “split” their gifts may give up to $20,000 in value per recipient per year without triggering the gift tax.

A systematic program of gifts made during life can significantly reduce an individual’s taxable estate at death. If properly channeled into, for example, a life insurance trust or a long-term growth-oriented investment (such as stock in a family business), a systematic gift program can also result in substantial wealth creation for the next generation, often at little or no estate or gift tax cost.

The Marital Deduction and Unified Credit Trusts
Property passing from one spouse to another, whether during life or at death, is free of federal estate and gift taxes because of the marital deduction permitted with respect to such transfers. This deduction can eliminate the tax on the estate of the first spouse to die, but without further tax planning, it often fails to result in an overall reduction in the ultimate tax burden. Instead, it merely delays the impact of that burden until the death of the second spouse.

For example, assume that John Smith has a net worth of $900,000 and his wife, Mary Smith, has a net worth of $450,000. Upon John’s death in 2000, he leaves everything to Mary, and there is no estate tax due because of the marital deduction. But on Mary’s death shortly thereafter, when she leaves everything to their two children, her net worth at death may well be $1,350,000 and her estate may owe a federal estate tax of $270,750.

In this example, use of the marital deduction avoided any tax on the estate of the first to die. A more tax efficient estate plan, however, would have avoided any tax on both estates through the use of a unified credit trust.

Again, assume that John has a net worth of $900,000 and Mary has a net worth of $450,000. But this time, assume that at John’s death in 2000, instead of leaving everything to Mary, he leaves $225,000 to her outright and $675,000 to a unified credit trust for her benefit during life, which at her death will pay out any remaining funds to their two children. As in the first example, there would be no federal estate tax at John’s death, because of the unified credit trust and the marital deduction. But on Mary’s death, when she leaves everything to their two children, her net worth is only $675,000 – the amount that is exempt from tax through the use of her unified credit. The amount in the trust, which is also paid out to her children at her death, is NOT included in her estate, so the federal estate tax due at her death is $0.

As these examples show, appropriate planning can save thousands (and sometimes hundreds of thousands) of dollars for your heirs.

The attorneys in our Trusts & Estates Department are available to assist you in reviewing and revising your estate plan.