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A. federal taxation

A. What is included in your taxable estate for federal purposes?

In a word, everything. Remember, the size of the probate estate has nothing to do with the size of the federal taxable estate. The 2001 estate tax law increased the amount of each person’s estate that can be sheltered from tax, but it did NOT change what is included in that estate.

For 2004 and 2005, if the value of a person’s, or married couple’s combined federal taxable estate reaches $1.5 million, the need for estate tax planning is triggered – unless death can be postponed a few years. This “trigger amount” is set to reach $3.5 million over the next few years after that.

The taxable estate includes:
– All property interests owned by you, or by a Trust you control outright, or by a Trust to which you have any significant “strings attached.”

– Qualified retirement plan proceeds. These were not part of the taxable estate under old law. Now such proceeds are includable, but a full or partial exclusion may be available to some persons who retired no later than 1984.

– Life insurance proceeds, if the policy is owned by the decedent or payable to the estate.

Part of the confusion associated with discussions on this topic can be cleared if one recognizes that we are dealing with at least two different taxes: Federal estate and gift tax is our main focus here, but the federal income tax consequences of any options you consider are important, too. Life insurance is a good example. Life policy proceeds are almost always received by the beneficiary with no income tax due. But, as stated, if the insured person owns the policy, those proceeds will be subject to estate tax when he dies. Additionally, you might have a state inheritance or estate tax to consider, as well.

State inheritance or estate taxes (“death” taxes) have historically been of much less significance in planning than federal tax – for one thing, state rates are much lower than the federal rates. Additionally, many states have used a “painless” system that charges the estate whatever is the maximum amount that can be subtracted directly from the federal tax tab, if any – so there’s no extra tax hit. (That amount is called the “state death tax credit.”)

But federal estate tax changes have been decreasing the amount of the state death tax credit allowed. The credit will be eliminated entirely in 2005. The likely loss of revenue to the states is huge. Will they sacrifice that revenue, or restructure their death tax systems to take it back? Planners should be alert to the issue of state taxes in the years ahead.

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