Hypothetical Facts
Mr. Jones is married and has three children, a daughter and two sons. He has a simple "I Love You" will, with all property to be transferred outright to his wife, if she is living, or in equal shares to his children, if she is deceased. Mrs. Jones has no significant personally owned assets. Four years prior to his death, Mr. Jones gave $20,000 to each of his children, treating them as split gifts ($10,000 from each spouse). At the time of his death, Mr. Jones has the following mix of assets:
| Savings/Investments |
$700,000 |
| Residence and Personal Property |
600,000 |
| Life Insurance (to Mrs. Jones) |
500,000 |
| Business |
1,200,000 |
| Total |
$3,000,000 |
Mrs. Jones subsequently dies ten months after her husband, leaving all property to her children, having made no additional taxable gifts. Here is how the federal estate taxes are computed for each estate:
| Mr. Jones' Estate — 2003 |
| Gross Estate |
$3,000,000 |
| Plus: Taxable Gifts |
0 |
| Less: Probate/Admin. at 2% |
(60,000) |
| Less: Marital Deduction |
(2,940,000) |
| Taxable Estate |
0 |
| Net Tax |
0 |
|
| Mrs. Jones' Estate — 2004 |
| Gross Estate (from Mr. Jones) |
$2,940,000 |
| Plus: Taxable Gifts |
0 |
| Less: Probate/Admin. at 2% |
(58,800) |
| Less: Marital Deduction |
0 |
| Taxable Estate |
2,881,200 |
| Tax |
1,204,000 |
| Credit |
(555,800) |
| Net Tax |
648,200 |
| Net to Children from Estate |
$2,233,000 |
| Lifetime Transfers to Children |
$60,000 |
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The marital deduction did not eliminate federal taxes, but simply deferred them to Mrs. Jones' estate. Mr. Jones' estate did not take advantage of a credit trust.
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If Mrs. Jones had died first, in 2003, her estate would be unable to "shelter" $1,000,000 — wasting a possible tax savings at Mr. Jones' death.
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Life insurance owned by Mr. Jones payable to Mrs. Jones was effectively hit by estate taxes at her death.
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The liquidity demand for $707,000 at Mrs. Jones' death (tax of $648,200 plus probate/ administrative costs of $58,800) may force a liquidation of the business interest. If the business had been specifically bequeathed to one child, the other children could be disinherited because of the tax costs.
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The business deduction is not available to the estates of Mr. or Mrs. Jones, since, among other limitations, the business value is less than 50% of his or her adjusted gross estate and the deduction is not available in 2004.
An Alternative Design
If we assume the Joneses were interested in saving estate taxes, here is an alternative design that would have little impact on their lifestyle, but make a significant difference to their family. The plan would call for Mr. and Mrs. Jones to create a two-part trust (one for the marital deduction, another for an amount equivalent to the credit exemption). In addition, Mr. Jones would transfer his life insurance coverage (by gift) to an irrevocable trust designed to provide income after his death for Mrs. Jones, and after her death, pass assets equally to their three children. Let us also assume Mr. Jones uses part of the annual gift exclusion to pay for the premium and he does not exceed the exclusion. Since Mr. Jones lived more than three years after the transfer of insurance, his personal estate at death would be worth $2,500,000.
| Mr. Jones' Estate — 2003 |
| Gross Estate |
$2,500,000 |
| Plus: Taxable Gifts |
0 |
| Less: Probate/Admin. at 2% |
(50,000) |
| Less: Marital Deduction |
(1,450,000) |
| Taxable Estate |
1,000,000 |
| Tax |
345,800 |
| Credit |
(345,800) |
| Net Tax |
$0 |
|
| Mrs. Jones' Estate — 2004 |
| Gross Estate (from Mr. Jones) |
$1,450,000 |
| Plus: Taxable Gifts |
0 |
| Less: Probate/Admin. at 2% |
(35,500) |
| Less: Marital Deduction |
0 |
| Taxable Estate |
1,414,500 |
| Tax |
519,000 |
| Credit* |
(555,800) |
| Net Tax |
$0 |
| Mrs. Jonesā?? Estate to Children |
$1,414,500 |
| Life Insurance Trust |
500,000 |
| Credit Trust |
1,000,000 |
| Total |
$2,914,500 |
| Total Net Transfers of First Plan |
2,293,000 |
| Advantage of Alternative Plan |
$621,500 |
Observations
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Additional administrative probate savings may be available, depending on state law, if a revocable trust held Mr. Jones' assets.
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This alternative plan did not shift assets during lifetime to Mrs. Jones, so that the credit could be protected if she had died first.
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The irrevocable life insurance trust can be designed so that the tax-free proceeds may be loaned to Mrs. Jones' estate to pay estate costs, or assets may be purchased from her estate so that her executor has cash to pay these costs.
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Additional annual exclusion gifts could have been made during Mr. and Mrs. Jones' lifetime to reduce their estate tax costs.
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The business deduction was not available at Mr. Jones' death, since the business value was less than 50% of his adjusted gross estate. The business deduction is not available to Mrs. Jones since she died in 2004.
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