Volume 14, Number 2 · April 2004

Does the Increase In Unified Credit Require A Change In Your Estate Plan

By Kenneth L. Baker

One of the essential ingredients of developing a proper estate plan over the last 40 years has been to take advantage of the unified credit (now the exemption equivalent) and marital deduction, to reduce or avoid Federal Estate Tax in the estate of the second spouse to die. In order to carry out that plan it was necessary to make sure that there were assets separately titled in the individual names of each spouse. Those assets were under the terms of the Will or Trust to be used to fund the unified credit up to its total amount. Any excess either passed to the surviving spouse outright or funded a Marital Deduction Trust, such as a Q-Tip Trust, and was not taxed in the estate of the first to die.

Formerly, when the unified credit was $600,000.00 or less, it was very common to employ this strategy in order to protect at least $1.2 million of property from Federal Estate Tax. At that time the highest rate for Federal Estate Tax was 55%. This type of plan gave up flexibility in order to produce tax savings. It also forced each estate to go through the probate process.

As a result of the Economic Growth and Tax Relief Reconciliation Act of 2001 the unified credit was increased effective in 2002 and 2003 to one million dollars, in 2004 and 2005 to $1.5 million, in 2006, 2007 and 2008 to $2 million and in 2009 to $3.5 million. In 2010, the Federal Estate Tax is to be totally repealed. But, in 2011, the tax resumes and the credit will go back to $1 million. The effect of this Act is that as the credit goes up, clients must review their estate plans to avoid paying too much tax or over complicating their estate plans. This review should not only include a review of the estate planning documents, but also a review of how assets are titled. In 2010 everyone who has assets in excess of one million dollars will need to review his or her plan. It is very difficult to know what will occur between now and 2010.

In addition to the increase in the unified credit, the maximum rate has been decreased from 55% in 2001, to 50% in 2002, 49% in 2003, 48% in 2004, 47% in 2005, 46% in 2006, 45% in 2007 and 45% in 2008. When the unified credit was under $750,000.00, the effective rate on the first dollar subject to tax was 37%. Thus, the effective rate has now gone up on the first dollar that is subject to tax.

The other change in the Federal law was the reduction of the Federal State Death Tax credit by 25% per year. In the year 2004 it is 25%. In the year 2005 there will be no Federal State Death Tax credit against Federal Estate Tax. In that year the estate will be permitted to take the Inheritance Tax paid as a deduction which is not directly equivalent to the Federal State Death Tax credit on the Federal Estate Tax Return.

The purpose of this article is to make our clients aware that as a result of the changes in the unified credit, changes in their estate plans may be appropriate. For instance, if the total assets of both spouses are less than $1.5 million and are unlikely to grow in excess of that amount prior to the second spouse's death, then a more simplified Will may be appropriate. In addition, the use of joint property which avoids probate on the death of the first of the spouses to die may be useful without creating an adverse Federal Estate Tax result.

Secondly, the use of disclaimer Trusts to permit the client to give all of the assets of the first spouse to die outright to the other spouse, unless there is a tax benefit to disclaiming to a Unified Credit Trust, is much more advantageous than prior to the change in the law. Through disclaimers, the surviving spouse is able to make a judgment of whether it is best to disclaim part or all of the assets in the estate of the first to die into a Trust which would guarantee that there would be no tax on the second spouse's death, or receive the assets from the first spouse directly without the need of a trust. The Disclaimer Trust gives the surviving spouse all of the income from the assets in the name of the first spouse to die which are disclaimed, as well as principal if the surviving spouse needs it for health, maintenance and support. This Trust can be beneficial both as a tax device and also as a device to manage the money that the first spouse had in his or her individual name, to save Pennsylvania Inheritance Tax and to act as a vehicle to assure that the money will pass to the beneficiaries under the Disclaimer Trust in the Will of the first spouse to die.

As a part of our representation of clients we want to make sure that if there is a way to either avoid probate entirely on the death of the first spouse (such as by joint ownership) or to pass more assets to the surviving spouse outright and avoid the complications of a Trust, that the option to do so is available to our clients. If your total assets are less than $1.5 million, and particularly if you have a Unified Credit Trust in your Will and assets have been divided to fund that Trust, we highly recommend you contact our office to review the plan in light of the tax changes that have occurred and are anticipated through the year 2011.

Our Estate Planning Department is comprised of Kenneth L. Baker, Richard J. Amrhein, John A. Rodgers and Susan Mondik Key. Please feel free to contact any one of our estate planning team for the purpose of reviewing your estate plan.

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