There are changes afoot for 2006 – estate tax changes. Gregg Simon, an attorney with the Chicago-based firm Much Shelist, offers a few highlights in this recent interview.

Q: What do you feel is the most significant change in estate tax law for 2006?

A: The biggest change is the increase in the amount that can be passed down to heirs estate tax free – it has moved from $1,500,000 to $2,000,000. This alone can save $230,000 of estate taxes. (As recently as 1997 the exemption was $600,000).

Q: What is the biggest mistake people make when it comes to their estates?

A: The biggest mistake most people make is not doing any planning. If significant planning is needed, you need to find an attorney knowledgeable in estate, gift and generation skipping taxes. Having the right attorney can not only save on taxes for the client and the client’s children, but for many generations to come. The same would be the case for creditor protection for the client’s descendants.

Q: Have recent news stories made a difference in the number of people asking for wills, powers of attorney, living wills, trusts and other estate documents?

A: There has been a dramatic increase in interest surrounding estate planning needs. This is partially due to the trillions of dollars of wealth being transferred from one generation to the next, but also because of heightened awareness due to news stories, including the possible repeal of estate taxes, the Terry Schaivo situation, etc.

Q: Is it safe for people to go online to places like LegalZoom.com and Nolo.com to buy estate documents? If you’re going to do this, what should you be aware of?

A: It can be very dangerous to go to a do-it-yourself legal website, especially when people do not understand what they need or the law behind the documents. This is especially true when it comes to apportioning estate taxes, and not knowing alternatives available and the differences in every states probate/trust and tax laws.

Here are other 2006 estate tax change highlights from Gregg Simon.

Annual Exclusion Gifts

For 2005, individuals can make an unlimited number of gifts of up to $11,000 per recipient, per year. If not made by December 31, 2005, the 2005 annual exclusions will be lost. For 2006, the amount of the annual exclusion will rise to $12,000 per recipient.

Tuition and Medical Gifts

Additional unlimited gifts can still be made by paying tuition costs or medical expenses directly to the provider.

Estate Tax Exemption

The amount that an individual may pass free of federal estate taxes will increase to $2 million next year and $3.5 million in 2009, becoming unlimited in 2010. However, in 2011 it will decrease to $1 million. Although President Bush continues to push for permanent repeal of the death taxes, there has been talk on Capitol Hill of a compromise that would raise the amount an individual can pass free of estate taxes to somewhere between $5 million and $8 million. This potential compromise may also lower the estate tax rate to the current capital gains tax rate of 15 percent. We are hopeful that legislation will be enacted in 2006, one way or the other, to provide certainty in the transfer tax laws and allow for proper planning.

Lifetime Gift Exemption

Although an individual can currently pass $1.5 million free of estate tax upon death, the same amount cannot be given away during lifetime without incurring a gift tax. The lifetime gift exemption remains at $1 million (in excess of the annual exclusion, tuition and medical gifts).

Estate and Gift Tax Rates

Under current law, the top estate and gift tax rate will decrease to 46 percent in 2006. It is also scheduled to decrease to 45 percent for 2007-2009 and 0 percent in 2010, rising to 55 percent in 2011.

Generation-Skipping Transfer Tax Exemption

In order to ensure a death tax at each successive generational level, a generation-skipping transfer tax is imposed on transfers to grandchildren or more remote descendants at the top estate tax rate. However, the same amount that can pass free of estate tax ($2 million as of 2006) can pass generation-skipping tax free to grandchildren and more remote descendants.

State Estate Taxes

The federal government no longer shares the estate tax with the states. To the extent that a decedent is subject to estate tax in his or her state of residence, the federal government now allows for a deduction. Illinois residents may incur state estate taxes at a top rate of 16 percent (which, after the federal deduction, results in a marginal rate of approximately 8.5 percent). Note: Several states, including Arizona, California, Florida and Nevada, currently have no estate tax.

Charitable Donations

The Katrina Emergency Tax Relief Act of 2005 (KETRA) allows some taxpayers to claim bigger charitable deductions than in the past by temporarily removing the charitable deduction limitations for cash gifts to “public charities,” even if they have no connection with Hurricane Katrina. However, the restrictions are only removed for contributions made between August 28, 2005 and December 31, 2005. If KETRA’s tax-saving provisions apply to your circumstances, you may want to consider accelerating your charitable donations from 2006 to 2005. For a more detailed discussion of the act, please see the related alert: KETRA Offers Tax Relief through Temporary Charitable Giving Incentives.

Family Limited Partnerships

Many clients have utilized Family Limited Partnerships (“FLPs”) for various planning benefits. Through 2005, the IRS has continued to attack the effectiveness of FLPs, particularly the transfer tax valuation reduction benefits. In some cases, the IRS has been successful in having the FLP ignored for estate and gift tax purposes, which makes the valuation discounts and the accompanying tax savings unavailable. The upshot of these cases appears to be that while FLPs remain effective estate planning tools, they must be entered into for bona fide non-tax purposes, the integrity of which is respected both in their creation and in their ongoing administration.

Anyone who is considering a Family Limited Partnership should remember these important points:

  • Assets must be retitled into the name of the FLP;
  • You should retain sufficient assets outside the FLP to live on (and to pay estimated estate taxes) without recourse to FLP assets;
  • You should not transfer personal use assets to the FLP (e.g., a residence or an automobile);
  • All distributions from the FLP should be made in proportion to the partnership percentages and should be determined based on partnership decisions, not on the needs of any one partner;
  • You should not treat the assets of the FLP as your own but run it like any other business with outside owners.

In addition, the IRS continues to attack FLPs at death based upon retention of certain control by the decedent. If the decedent created/transferred the bulk of the assets to the FLP and retained the power to control the timing of cash flows to the partners (including liquidation), the IRS has argued (successfully in one Tax Court case) that the FLP assets can be included in the decedent’s estate. This issue does not arise in the gift context.

Funeral/Cremation

Effective January 1, 2006, Illinois has a new Disposition of Remains Act. Previously, an individual (“principal”) could designate an agent, through a health care power of attorney, to make medical decisions, including disposition of remains at death. The new act provides additional requirements for designating a disposition of remains agent. If no designation is executed, the act specifies who can make the decision for you (your executor, spouse, children, parents, next of kin or any other person willing to assume legal and financial responsibility). If you have specific desires regarding disposition of your remains and/or if you want to designate a particular individual to act on your behalf in that regard, you should consider executing a Disposition of Remains Agent Designation.

About Gregg Simon

Gregg M. Simon is Chair of the firm’s Wealth Transfer & Succession Planning group. He concentrates his practice in estate planning, federal estate and gift taxation, probate and trust administration, and business planning. Email Gregg at [email protected].

Dec. 27, 2005.