IV. ITEMS INCLUDED IN THE GROSS ESTATE

A. An "estate" for tax purposes includes all of a decedent's cash, stocks, bonds, securities, personal property, bank accounts, interests in real estate, partnerships, closely held corporations, receivables, and promissory notes.

B. "HIDDEN" ASSETS. In addition to the usual assets noted above, a decedent's estate also includes the value of life insurance proceeds paid to another if decedent retained any control over the policy, pension benefits or annuities if they continue to be paid to another (survivorship benefits); jointly owned personal and real property; unpaid salary and commissions due; options, warranties and royalties; property subject to decedent's power of appointment or in which the decedent retained a life estate; coin, antique and art collections; property held in the decedent's revocable trust; and gift tax paid within three years of death.

C. Many people neglect to include the value of "hidden" assets in deciding whether estate planning is necessary for tax purposes.

V. GIFT AND ESTATE TAX RATES

The Estate and Gift Tax structure is a progressive tax like the income tax. For instance, the rate is 41% on estate assets between $1,000,000 and $1,250,000. The highest tax rate is 50% for estates and gifts in excess of $2,500,000. 

VI. ESTATE PLANNING TECHNIQUES

A. MARITAL DEDUCTION. Bequests and amounts passing to a surviving spouse that pass outright or in a qualifying trust will be deducted from the adjusted gross estate. For tax planning purposes, it is not always advisable to leave everything to a spouse since this stacks all assets into one estate that may be taxed if both unified credits are not used effectively. Please note that the unlimited marital deduction only applies to decedents who are citizens or residents of the United States whose spouses are U.S. citizens. For non-U.S.-citizen spouses, it is possible to take advantage of the unlimited marital deduction through use of a Qualified Domestic (QDOT) Trust or by the resident spouse becoming a U.S. citizen before the estate tax return is filed.

B. There is an unlimited marital deduction for all lifetime and testamentary transfers. This means that transfers between spouses are not subject to gift or estate taxes regardless of the value transferred.

VII. $11,000.00 ANNUAL GIFT TAX EXCLUSION

A. GENERALLY. The annual gift tax exclusion is currently $11,000 per donee.

B. GIFT-SPLITTING. Gift-splitting is still permitted so that spouses can transfer up to $22,000 per donee annually, but a gift tax return will be required for gifts which are split.

C. ANNUAL GIFT TAX RETURNS. Gift tax returns and payment of gift tax is due on an annual basis before April 15 following the calendar year in which the gift is made. Also, an extension of time for filing the donor's individual income tax return will automatically extend the time for filing the gift tax return.

D. GIFT TAX EXCLUSION FOR MEDICAL OR TUITION PAYMENTS. There is an unlimited gift tax exclusion for amounts paid for an individual's medical expenses or school tuition. Payments must be made to the educational institution or health care provider directly by the donor. If the donor reimburses the donee for these expenses, the exclusion does not apply.

E. ESTATE PLANNING OPPORTUNITIES. The increased annual exclusion should make annual gifts a significant and useful tool in shifting assets free of any transfer taxes.

1. EXAMPLE. A married couple with four children could use gift-splitting to transfer $880,000 over a ten year period to their children without any transfer taxes.

VIII. COORDINATING THE UNLIMITED MARITAL DEDUCTION AND EXEMPTION LEVELS

A. PLANNING CONSIDERATIONS. Although it is possible to defer payment of estate taxes until the death of a surviving spouse by using the unlimited marital deduction, this will not usually result in the greatest estate tax savings. Overfunding the marital bequest will increase the taxes payable upon the death of the surviving spouse. If husband and wife have a combined estate of more than $1,500,000, estate "splitting" can reduce or eliminate taxes.

1. EXAMPLE. Husband has an estate worth $3,000,000 and Wife has no separate property. If Husband left everything to Wife, his estate tax would be zero but the federal and Virginia estate taxes on Wife's estate would be $1,016,000. However, if Husband left only $1,500,000 to Wife and put the balance in a bypass trust or left it outright to other beneficiaries, Husband's estate tax would still be zero and Wife's estate tax would also be zero. This assumes Husband dies first and Wife dies before the exemption increases. If Wife died first in this example, no marital deduction would be available to Husband and he would incur an estate tax of $1,016,000. Husband should consider making lifetime gifts to Wife to equalize their estates so that each estate would use the available credit regardless of the sequence of their deaths.

B. THE "CREDIT TRUST" APPROACH. One of the most important techniques to use in balancing equalization and deferral of estate taxes, is the "credit trust," "bypass trust", "minimax" or "reduce to zero" clauses. These formula clauses define the marital share essentially as so much of the estate as is necessary to reduce the taxable estate to the exemption equivalent level. The balance is placed in a "family trust" or left to other beneficiaries. Using these clauses can shelter at least $1,500,000 from inclusion in the surviving spouse's estate.

IX. JOINTLY-OWNED PROPERTY

A. GENERALLY. Currently, one-half of the value of property held jointly by decedent and his spouse with the right of survivorship will be included in the estate of the decedent spouse regardless of who furnished the consideration.

B. Significant effects:

1. Only one-half of the value of the property receives a "stepped-up" basis in the hands of the surviving spouse for income tax purposes.

2. Certain favorable estate elections depend on percentage tests which relate to the size of the gross estate, i.e. redemption of stock to pay death taxes under Section 303, special use valuation under Section 2032, deferred payment of estate tax under Section 6166.

D. The "Consideration Furnished" test applies for all property owned jointly with the right of survivorship between any two people who are not married. Therefore, it is necessary to trace the relative contributions made by joint owners who are unmarried. There is a presumption that the whole value will be included in the decedent's estate unless and to the extent that the co-owner can prove that he or she furnished consideration for the property.

X. THE TAX FREE STEP-UP IN BASIS

A. GENERALLY. Assets that are included in decedent's estate have a basis in the hands of a beneficiary equal to the fair market value on the date of death, hence unrealized appreciation is not taxed.

1. EXAMPLE. Dad buys 100 shares of IBM stock at $10 per share in 1970. On the date of Dad's death, the stock has a fair market value of $100 per share. The shares are included in Dad's gross estate at $100 per share and the beneficiary of the shares under Dad's will has a basis of $100 per share. If Dad had sold the stock, he would have realized a long term capital gain of $90/share.

2. NOTE. The 2001 Tax Act will modify the ?stepped-up? basis rules so that not all assets will receive a full basis increase to their value on the date of death. Starting in 2010, up to a total of $1.3 million in basis step-up may be allocated to aggregate transfers to any beneficiaries. An additional $3 million of basis step-up may be allocated to transfers to a surviving spouse. For all other assets transferred at death, the value of a decedent?s assets will be based on the lesser of the adjusted basis of the decedent or the fair market value on the date of death.

XI. CHARITABLE GIFTS.

A. GENERAL. Any consideration of charitable gifts should be prompted by a philanthropic desire to benefit charity, not by the tax benefits that will accrue as a result. Tax benefits accorded charitable gifts cannot make the donor whole for the relinquishment of his property. They can only reduce the net cost of the gift.

In an estate planning context, the threshold question concerning charitable gifts is often whether to make the gifts during life or defer the gift until the donor's death. Lifetime charitable gifts often present the more attractive option from a tax planning perspective, principally because the donor may realize some immediate income tax savings as a result of the gift, and having donated the property during lifetime, it will not be included in his taxable estate. If, on the other hand, the donor retains the property until death and then bequeaths it to charity, his estate will benefit from the estate tax charitable deduction. However, that will just put the estate in the same position it would have been in had the property been given to charity during the donor's lifetime. No income tax saving would, however, have been obtained.

As with non-charitable gifts, the simplest method is an outright gift or bequest. Unlike the income tax limitations, there are no estate tax or gift tax limitations on the size of the charitable deduction that can be claimed. One hundred percent of the value of the gift can be deducted and as much as one hundred percent of the estate.

B. SPLIT-INTEREST GIFTS. The virtue of outright gifts is simplicity. The disadvantage is that the donor has forever and completely parted with any benefit from the property for himself or other members of his family. Often, therefore, the donor will want to structure the gift so that non-charitable beneficiaries also will derive some benefit from the donated property.

There are several methods of making gifts which are partially for the benefit of non-charitable beneficiaries and partially for the benefit of charity. There are very technical and unyielding rules that must be complied with in order to get any tax deduction for these split interest charitable gifts. They should be planned and drafted with great care by competent legal counsel.

1. CHARITABLE LEAD TRUSTS. As the name implies, these are charitable split interest trusts where the charitable portion "leads" or comes first. A gift tax deduction is allowable for an interest passing to charity if "such interest is in the form of a guaranteed annuity or is a fixed percentage distributed yearly of the fair market value of the property." A similar rule applies in the case of an estate tax charitable deduction. Thus, property might be transferred to a trust with the direction that "X" dollars per year be paid to charity for "Y" years and at the conclusion of that term the principal paid out to family members.

2. CHARITABLE REMAINDER TRUST. The reverse of a charitable lead trust is a charitable remainder trust. Here, the lead interest is for a non-charitable beneficiary and the remainder interest is for charity. A deduction is available for estate and gift tax purposes for the present value of the remainder interest.

Two types of charitable remainder trusts are sanctioned by the Code - a charitable remainder annuity trust and a charitable remainder unitrust. An annuity trust is one where the income interest is fixed as a sum certain which is not less than 5% per annum of the initial net fair market value of the trust corpus. A unitrust is one where the income interest is fixed as a per annum percentage (not less than 5%) of the net fair market value of the trust, valued annually.

3. POOLED INCOME FUND. Yet another vehicle for deductible split interest gifts is a pooled income fund. These are funds set up by charities to facilitate split interest gifts from donors. It spares the donor the necessity of drafting a complex separate charitable remainder trust; he simply contributes to the pooled fund and designates the person or persons who are to receive the income from his proportionate part of the fund.

C. VALUE OF GIFT. A gift of property to a qualified organization is a charitable contribution to the extent of the property's fair market value at the time of the gift. This is generally the case, even if the contribution is of appreciated property (property whose fair market value exceeds its basis to the donor).

XII. MARRIED COUPLE WITH COMBINED ASSETS EXCEEDING $1,500,000

A. As the preceding examples indicate, if you and your spouse have an estate exceeding $1,500,000, you should consider establishing "bypass trusts" so that each of you effectively use your $1,500,000 exemptions. The surviving spouse will be the beneficiary of the bypass trust during his or her remaining lifetime. See Case Study #1 and #2 at the end of this memo.

B. The crucial point in this arrangement is that the bypass trust will not be included in the surviving spouse's estate. This can result in an estate tax savings of $1,016,000.

C. Note also that signing documents which create bypass trusts will not accomplish anything if all assets remain jointly owned with the right of survivorship. We must break up joint ownership and retitle assets into the name of each spouse individually.

XIII. MARRIED COUPLE WITH COMBINED ESTATE LESS THAN $1,500,000

A. If your estate does not exceed $1,500,000 and you do not expect it to exceed $1,500,000 at the time of death of the surviving spouse, you do not need to worry about estate taxes because the survivor's exemption will protect the estate from all estate tax.

XIV. SINGLE INDIVIDUAL WHOSE ESTATE EXCEEDS $1,500,000

A. If you are single and your estate exceeds $1,500,000 you have estate tax exposure if you die before 2004. You might consider making gifts to reduce your estate. Every person has an annual gift tax exclusion of $11,000 per donee so that you may give $11,000 annually to each prospective beneficiary, to reduce your estate on a tax free basis.

B. You should also consider some of the other techniques described below.

XV. SINGLE INDIVIDUAL WHOSE ESTATE DOES NOT EXCEED $1,500,000

A. If you are single and you do not expect your estate to ever exceed $1,500,000, you do not need to worry about estate taxes.

XVI. OTHER TECHNIQUES FOR MINIMIZING ESTATE TAXES