New England Forestry Consultants, Inc.
|Volume 5, No. 1
Estate Planning - Part II Keeping the Land in the Family
Let's be honest, many landowners do not want to plan their estates because it requires them to contemplate their own death. The subject is seldom brought up in family discussions because the potential heirs are concerned that doing so will give the appearance of greediness, and the owners don't want to raise the issue because it requires them to make decisions affecting their family while facing their own mortality.
In the winter 2001-2 NEFCo newsletter, I made a guarantee; that guarantee being that at some point in the future, you are going to die. I also pointed out that you could either ignore the inevitable and accept the fact that the government would receive the majority of your estate, or you could plan ahead and insure that your heirs benefit from your foresight and hard work. Planning ahead is defined as Estate Planning and is an integral part of active land management.
The reasons that an individual or couple should plan their estate include the following:
- Avoiding the cost of probate expenses.
- Keeping the family lands in tact and in such a manner to benefit their heirs.
- Continuation of land stewardship.
- Eliminating or reducing the estate tax due to the government.
There are a number of ways of accomplishing these objectives. As mentioned in the winter 2001-2, the value of one's estate can be lowered using conservation easements. Other options include Family Partnerships, Limited Liability Companies, and setting up an appropriate trust. These options have either been reviewed in previous newsletters or will be addressed in future editions. This particular article will review the reasons for estate planning from an estate tax perspective and the concept of forming a trust.
Let's talk about estate taxes, or as some call it, the "death tax". The Unified Gift and Estate Tax rules allow a taxpayer to shelter otherwise taxable gifts, plus the final estate, with a "credit" that for most tax payers covers the tax due on the sum of taxable gifts and the taxable estate. In 2002, for instance, the exemption was $1.0 million, and this amount increases per year according to the rate of inflation. In 2009, the exemption jumps to $3.5 million. In 2010, there is no tax. In 2011, if the current law in not sunsetted, the rules revert back to the Taxpayer Relief Act of 1997. If this happens, the exemption drops back to $1.0 million per taxpayer plus adjustments for inflation. Any amount above the "credit" amount is taxed at a beginning rate of 37 percent on the dollar.
Now, I know what most of you are thinking. You are thinking that you do not need to worry about the death tax because your estate value will never be above the "credit" amount. Don't be so sure. If you take a hard look at your assets - especially if you own land - you may find that you are much closer to that "credit" amount than you realize.
Your estate value is the value of all of your assets. This amount includes, but is not limited to, your house, your life insurance policy, your land, and any other assets you might own. If you do the math, there is a strong possibility that your estate is worth much more than you realize. Even if your estate value is only $100,000 over the "credit" limit, the tax bill on that $100,000 is $37,000. This figure is more cash than most families keep on hand, and the tax could force the selling of an asset from the estate to pay the tax.
The value or appraisal of the land asset owned by an individual is often a surprise. By law, land must be appraised at its "highest and best" economic use. This requirement usually means land is appraised at its value for development of building lots. The appraisal is not based on how you are using the land, but on its potential highest and best use. What you paid for the land is irrelevant. The town assessed value of the land is irrelevant. It is quite feasible that forest land purchased 20 or 30 years ago for $20,000 may now have an appraised value of $300,000 to half a million dollars. For example, I was saddened to learn that a client of mine passed away and am helping the family with estate information. The 125 acres of forestland now owned by his estate is assessed by the town for $98,000 dollars. The result of a recent appraisal for estate tax purposes has appraised the value of that same 125-acre parcel at almost $400,000 dollars. Obviously, this is a clear example that using a town assessment value is not a good method of determining if estate taxes are something you should be concerned about.
Unified Credit Trust
One way to lessen the taxable estate value for a married couple is the formation of a unified credit trust, also known as a living trust and/or an A/B trust.
Under the "Unified Gift and Estate Tax Rules," the IRS allows every taxpayer a full tax credit. In 2002, this credit was $1,000,000. This amount was tax exempt. A spouse, however, can inherit an estate of unlimited value from a deceased partner. Sounds great right? Well here's the kicker, when the second spouse dies only one exemption is allowed. The value of the first spouse's exemption is lost unless the couple set up a unified credit trust. Simply stated, the trust allows the use of twice as much "credit" than if the trust were not established.
A trust is a separation of the legal and beneficial interests in property. In the Unified Credit Trust, the legal and beneficial interests are separated between the spouses, but the Trustees are usually the beneficiaries until they die. When one of the spouses passes away, the "credit" available that year shelters up to that amount from taxation. However, here is the true advantage of this situation: the income from the decedent's trust, and the assets themselves, are available to the surviving spouse. When the surviving spouse passes away, the "credit" available that year shelters the other half of the trust.
At an estate planning workshop, Thom McEvoy, Extension Forester at the University of Vermont, gave the following example to illustrate the advantages of the trust.
A husband and wife purchased 300 acres of forestland in 1953 for $45,000. In 2002, the land is worth $900,000. Combined with their other assets, the total estate in 2002 is worth $1.4 million. The husband dies in 2002 leaving the entire estate to his wife who inherits the assets tax-free. In 2004, when the total estate is worth $1.6 million, the wife passes away leaving the land and other assets to her children. The taxable estate is $600,000 ($1.6 million minus a $1.0 million exemption). The total tax due is $210,000.
Consider the same couple, same land, same values, but in this case, they decided to create a "Unified Credit Trust" in 2002, placing half the value of their assets in a trust under the wife's name, and the other half in a trust under the husband's name. The husband dies in 2002, and approximately half of their total estate is sheltered by the Unified Gift and Estate Tax exemption that is available in 2002 - $1.0 million. The wife can use the income from her husband's trust or the assets themselves while she is alive, or the husband's trust can be disbursed to his heirs. The choice is up to the husband and wife at the time they set up the trusts.
When the wife dies in 2004, her trust is sheltered with the $1.0 million (plus the rate of inflation since 2002) exemption. If her trust is half the total estate, it has about $800,000 of assets in it, and this amount is fully sheltered by the $1.0-plus exemption in 2004. The total tax due is $0. That's right, there is no tax due! The family without the trust paid $210,000. The family with the trust - $0 dollars.
Not only did the family with the trust not have to pay a "death tax", but they also did not have to go through the probate process. That is an additional savings of $5,000 to $15,000 just in probate costs alone.
Does it sound too good to be true? Yes it does, but this is the real deal. The Unified Credit Trust is a perfectly legal and logical strategy to protect assets from estate taxation.
Estate planning is just as the name implies. It is planning ahead to insure that your estate is distributed as you choose. None of us acquire and manage our properties with the goal of providing tax money to the government. We do it for our heirs and our love of the land. In order to meet your long-term objectives, you must plan ahead. Please consider the possibility that the value of your estate is much greater than you realize, and that you land assets will be appraised on their "highest and best" use rather than on how you use them. One way to eliminate or limit the burden of estate taxes on your heirs is the formation of a "unified credit trust". It is a relatively inexpensive investment, and in fact should be considered invaluable to the security of family lands. Please contact your nearest NEFCo forester for more information concerning estate planning. We can assist you in getting the process started.
- Tony Lamberton
McEvoy, T.J. 2002. Keeping Forestlands Intact - Estate Planning Changes to Think
About. Forest Products Equipment Journal. April Issue, pp 23-35 (4).