**Laws change frequently, and each individual's situation is unique. Therefore, the following article is not intended as legal advice. To obtain particularized, up-to-date legal advice, please contact us.**

An estate plan should insure that one’s property is managed and ultimately disposed of as the owner wishes and eliminate or minimize estate taxes. A proper estate plan should also consider the non-tax costs and the administrative burden associated with implementing the plan. A proper estate plan should insure that minor children are raised by those who their parents appoint, in the event of the their untimely death, and that the assets allocated to the children are managed in a manner and by a person of the parents’ choosing - rather than leaving it to a court to decide.

Estate Tax Rules and Considerations

1. Taxable Estate. 

The relative no one wants to leave money to is Uncle Sam. In 2001 Congress substantially increased the federal exemption level. In the past, Washington State's death tax was linked to the federal tax. If there was no federal estate tax, there was no state death tax. If there was federal estate tax, a credit was given for any state death tax paid. Unfortunately, Washington State isn't willing to bury its own death tax. Washington has decoupled its estate tax from the federal system. The State exemption level is far less than its federal counterpart.

The following tables illustrate the net estate a decedent may possess (exemption amount) without federal or Washington State estate taxes being imposed -- depending on the year of death.

Year of Death	Exemption Level
2005	$1.5 million
2006	$2 million
2007	$2 million
2008	$2 million
2009	$3.5 million
2010	N/A (tax repealed

Year of Death	Exemption Level
2005	$1,500,000
2006	$2,000,000
2007	$2,000,000
2008	$2,000,000
2009	$2,000,000
2010	$2,000,000

Although the federal estate tax is extinguished in 2010, it is set to resurrect in 2011 with a one million dollar exemption unless Congress acts.

For the next few years, and depending upon what Congress does in 2011, it is quite possible to face Washington State estate tax even if one's estate is exempt from federal estate tax.

2.  Marital Deduction.

A decedent’s estate receives a deduction for all property left to the surviving spouse. Thus, no matter what one’s net worth might be, if all property is left outright to the surviving spouse there would be no estate tax upon the first spouse's death. The problem is that the property left to the spouse would then be taxed upon his or her death to the extent the net worth of the estate exceeded the exclusion level.

The estate tax limitation goal of any proper plan is to take advantage of the marital deduction coupled with the exemption amount (also referred to as the unified credit) in order to avoid estate taxes at the first death, and limit or avoid taxes at the second death. The tricky thing is that now the State exemption level is less than the federal level.

What is considered one’s taxable estate? One’s taxable estate includes one-half the value of the community property and any separate property. One’s taxable estate includes life insurance proceeds paid on account of the decedent’s death or, 50% of the cash surrender value of life insurance on the surviving spouse’s life.

One's taxable estate also includes one-half of the community property portion of retirement accounts. For example, if a decedent is the unemployed spouse, his or her estate nevertheless includes 50% of the accumulated value of the retirement of the working surviving spouse.

Whether property is included within one’s taxable estate is not controlled by the method by which the property is transferred or not transferred at death.

3.  Tax Rates.

Washington State and federal estate tax rates rapidly climb and eventually reach a maximum of 45%.

Annual Gift Tax Exclusion

You may gift $12,000 per year to as many recipients as you wish. So, a married couple could give $24,000 per year to each child gift-tax free and thereby reduce their estate and/or perhaps slow the growth of their estate, in order to eliminate or avoid estate taxes at death.

Stepped Up Basis

In considering a gift program, one must compare the estate tax consequences with the income tax liability upon a sale of appreciated property. Both halves of the community property receive a stepped-up basis to date-of-death value at the time the first spouse dies. So, if one owns an apartment house that is worth $200,000 at death and it has been depreciated to where its tax basis is $50,000, a sale before death would result in a $150,000 gain subject to income tax. However, if this property were sold after the first spouse dies, one half of its value would be included in the decedent's estate but the entire asset would receive a "stepped up" basis. The income tax on gain would be avoided. When one gifts property, the recipient receives the tax basis of the donor. Thus, to the extent that one gifts appreciated real estate to their children, while it takes property out of the estate and eliminates the estate tax liability, the donee receives it at a lower basis, and thus is subject to income tax liability should he or she sell it for more than what its tax basis was in the hands of the donor.

In general, income tax rates are substantially lower than estate tax rates and therefore while this is an important matter to consider, it still may be prudent to gift appreciated real estate even though the recipient will lose the "stepped-up" basis that he or she would obtain by means of inheritance rather than a gift. For example, assume you own an apartment house that is worth $150,000 and has a tax basis today is $50,000. If both parents were to die and their children were to inherit that apartment house, they could sell it for $150,000 and avoid any income tax. However, it would be included in your estate subject to estate taxes. Now, if one's parents were to gradually gift that apartment house to the children by means of the annual exclusion, the children would have a lower basis and thus income tax liability should they sell it, but that income tax liability would undoubtedly be less than the estate tax liability if they were to receive it by means of inheritance.

Another example. If one purchases a share of Pepsi stock at $30 and thereafter sells it at $50, he has $20 of gain subject to income tax. If he gifts the share of stock and the recipient sells it, he too has the same gain. But if one dies, the stock is valued to determine the amount of the decedent’s taxable estate. And the estate assets, including the stock, receive a stepped up basis to date of death value. Thereafter, whoever inherits that share of stock could sell it at $50 and have no income tax liability.

Estate Transfer Documents

WILL SUBSTITUTES

Particularly for parents with young children, we feel a will is necessary so that one may appoint a guardian. For many people, much of their property may be transferred at death without regard to a will. For example:

Joint Tenancy with Right of Survivorship. If one registers a bank account or a brokerage account containing various investments in the form of joint tenancy with right of survivorship, the assets in said account pass to the surviving joint tenant at the first death.

Beneficiary Designations. Not only does life insurance pass to the named beneficiary (so long as there is no violation of the surviving spouse’s community property rights) so too may retirement accounts be left outright to a named beneficiary rather than having their disposition controlled by one’s will.

Trusts. Property may be transferred in trust to a named trustee, who may be the grantor of the trust. The trust may include instructions for the transfer of the property upon the death of the grantor. These arrangements are sometimes referred to as living trusts. We often utilize trusts for older clients, particularly clients who own real estate in another state. If one transfers all of one’s property into a revocable trust, and diligently manages to take title to all future acquisitions in the name of the trust, the use of the trust may avoid the administrative expense involved in probating a will. This may well be a benefit for an older client who would not have to incur the expense in both time and money in managing such a trust for many years.

In general, we don’t feel that revocable living trusts are an appropriate estate planning tool for younger married couples. The cost of preparing a trust is two to three times that of preparing a will and the cost in both time and money of maintaining the trust continues on an annual basis. See related article, "Do You Really Need A Living Trust?"

And what is often not understood by clients who have heard about living trusts is that a properly drafted will has the same estate tax avoidance features as the trust. In other words, one does not avoid estate taxes by using a living trust instead of a will. The purpose of a living trust may be to avoid the expense of a probate - which expense has to be compared to the expense of both time and money in creating and managing the trust. See related article, "Wills v. Living Trusts."

Care must be taken that arrangements set forth in will substitutes are not in conflict with one’s will. For example, if one executes a will that provides all property at death shall pass the surviving spouse, yet names a child as the joint tenant on a bank account or beneficiary of a insurance policy, there would be a conflict between that designation and the wording in the will. Normally, these specific designations set forth in the will substitute would control over the will.

WILLS

A will determines who should receive the testator's property, any limitation on the use of the property, and how it should be disposed of.  Also, if the testator has minor children, a will can be used to appoint a guardian to care for and manage the assets of the children.

If one’s net worth exceeds the state or federal exemption level or if a married couple’s net worth may exceed that figure, we usually consider providing for the option of a trust to be created at the time of the first death in order to maximize the possibility of estate tax avoidance. One should consider leaving in trust up to the amount equal to the state exemption level. This will be included in the decedent’s estate, but because it does not exceed the limit there will be no estate taxes. The surviving spouse receives the income from said trust, and the balance left in the trust upon the death of the surviving spouse will not be included in his or her estate but will pass directly to the couple’s children.

Such a trust can be mandated, i.e., the decedent requires that his or her property be placed in the trust - this is referred to as a credit shelter trust will.  Or the decedent may leave the decision whether to utilize a trust to the surviving spouse, who can determine whether the use of a trust will help avoid taxes at the time of his or her death. This option is known as a disclaimer trust will.

Other Estate-Planning Considerations

DURABLE POWER OF ATTORNEY

    If a person becomes incompetent, a petition for guardianship may be filed with the county court and after a fairly expensive and lengthy process, a guardian may be appointed to manage the disabled person's affairs.  A durable power of attorney prepared at a time before the principal becomes disabled avoids the need for a guardianship.

    With a durable power of attorney one appoints a trusted person to manage his or her affairs, including the option to make health care decisions, should he or she become disabled.  Usually, a durable power of attorney is effective at the time it is signed, but it is not sued unless the principal in fact becomes disabled.

HEALTH CARE DIRECTIVE

    By means of a health care directive people inform their family and physician whether they desire to be kept alive through artificial means should they have a terminal condition and be on life support systems.