The Economic Growth and Tax Relief Reconciliation Act of 2001 was proposed by the President and passed by Congress in order to help stimulate the economy out of the recession that began at the start of this decade. The stock market bubble that burst in 2000, as well as the events of 9/11, required drastic action by the government to avoid a prolonged recession or even a depression.  This law, which provided long-term individual tax relief along with the Federal Reserve’s monetary policy, helped the US economy get back on its feet by 2003.  As we enter 2006, it is a good time to look at the changes to the Federal estate tax code this law created and how they may affect your financial plan.

The Main Issue – The Exclusion Amount

For the past two years (2004 and 2005), the estate tax exemption has been $1.5 million, up from $675,000 in 2001. This year (2006), the exemption increased to $2.0 million per person.  This means that if your individual taxable estate is less than $2 million, you will owe no federal estate tax. In contrast, if your per-sonal estate is larger than $2 million, you will pay up to 46% on the value of the estate over $2 million.  Thus, it is very important to focus on how much of the family’s assets each spouse owns in their name.

Who Owns What – Is It Important?

Most people own their homes jointly. Retirement accounts such as pension plans, IRAs and 401(k) plans are always in one name, but usually pass directly to the spouse as a beneficiary.  In both of these cases, the $2 million exemption for one spouse may be lost. The ultimate goal is to have 50% of assets in one spouse’s name and 50% in the other’s name.  When the first spouse dies, these assets should go to a trust rather than directly to the surviving spouse.  This strategy can protect both spouses’ estate tax exemption.

Let’s take a hypothetical family with a net worth of $4.0 million and look at the estate tax bill in different scenarios. In scenario 1, the physician has all assets in the spouse’s name, for asset protection. In this situation, there would be serious tax consequences upon the spouse’s death. The first $2 million is exempt, but the next $2 million of assets is subject to the 46% estate tax costing $920,000.

In scenario 2, the assets are divided evenly between both spouses and they each take full advantage of the $2 million estate tax exemption.  At the first death, $2 million would fund a trust.  Upon the second death, there would be no federal estate tax.

The Exemption- One & Five Years from Now

The $2 million estate tax exemption will be in effect from 2006 through 2008. In 2009, the exemption increases to $3.5 million (good news) and in 2010 the estate tax laws will be repealed altogether (great news).  However, the exemption goes back to $1 million in 2011 if no new legislation is enacted.  Most likely, Congress will deal with the uncertainties of this law before the complete repeal in 2010. 

Conclusion

As your financial wealth grows, so will your need for a comprehensive investment and financial plan. A qualified financial advisor will help you develop, implement and monitor a plan to minimize estate taxes taking into account current estate tax laws and exemptions.