A version of this article was published in The Daily Record on October 15, 2001.
It is frequently said that there are two things in life that are certain--death and taxes. With the recent enactment of the Economic Growth & Tax Relief Reconciliation Act of 2001 (2001 Act), some may believe that death is now the only true certainty. However, the rumors surrounding the complete repeal of the estate tax are greatly exaggerated. Beginning in 2002, the Act will impact all people who have amassed wealth, including physicians, by lessening their estate tax burden, and by eliminating estate taxes for those people who have the presence of mind to die precisely in 2010. More specifically, the Act will gradually reduce the estate, gift and generation-skipping transfer tax rates, until full repeal of the estate tax in 2010, and gradually increase the amount of assets that are exempt from estate tax (the applicable exclusion amount) to a maximum of $3.5 million in 2009. Absent additional action by Congress, however, the estate tax will be reinstated on January 1, 2011, and the applicable exclusion amount will revert to $1,000,000 in 2011. While these changes have complicated estate planning because of the inability to predict the rules that will be in effect on the date of a particular person's death, they have for the same reason made proper estate planning more important than ever before. Therefore, an understanding of planning issues is important to all individuals, especially high income earners, such as physicians. A. Federal Estate Tax The federal estate tax is calculated on the value of the gross estate (that is, the value of all property owned by a decedent or in which a decedent has an interest on the date of the decedent's death), less a deduction for certain costs and expenses (for example, funeral expenses, debts, attorneys' fees and estate administration expenses). Other available deductions include a marital deduction for property passing to a surviving spouse, and a charitable deduction for property passing to charities. Also, assets equal to the "applicable exclusion amount" are exempt from federal estate tax. B. Repeal/Reduction of Estate Tax As a result of the 2001 Act, the applicable exclusion amount (and the estate tax rate on those assets not exempt from the tax) will increase or decrease as follows:
C. Practice Value Since the federal estate tax is calculated on the value of the gross estate on the date of death, obtaining an accurate and reliable valuation of all assets is critical when a federal estate tax return must be filed. In a physician's estate, one of the most difficult assets to value is the physician's practice. If the value of the physician's practice has not already been set by a buy sell agreement executed by the physician's partners, then to minimize the risk of a federal estate tax audit, it is advisable to obtain professional assistance for the valuation. Elements of the practice that should be considered in the valuation process include any real estate, equipment and supplies owned by the practice, as well as accounts receivable, and goodwill. D. Retitling of Assets For a married physician, one of the simplest ways to reduce federal estate taxes is to retitle jointly owned assets, such as stocks and bonds, into individual names. Once retitled in the name of one spouse, the asset will not be part of the other spouse's estate upon death. This retitling can, therefore, lower the value of a physician's estate. Moreover, appropriate retitling of assets can ensure that each spouse has enough assets in his or her own name to allow the couple to make use of the applicable exclusion amount no matter which spouse is the first to die. E. Family Trusts Substantial estate tax savings can be achieved if a trust commonly referred to as the "Family Trust" or "Bypass Trust" is utilized. The Family Trust is funded at the time of death with assets equal to the applicable exclusion amount, which is currently $675,000, but which will increase as indicated in the chart until total repeal of the estate tax in 2010. Any assets that remain after funding the Family Trust could pass to the surviving spouse outright or through a marital trust. The Family Trust usually provides that the surviving spouse is entitled to income from the Trust for his or her lifetime, and also provides for discretionary payments of principal for the spouse's or the descendants' health, education, maintenance and support. Upon the death of the surviving spouse, the Family Trust will terminate or continue for the benefit of the descendants. The benefits of the Family Trust are that (1) assets equal to the applicable exclusion amount pass to the trust upon the death of the first spouse without the payment of estate taxes, and (2) those assets are also not taxed upon the death of the second spouse, because the second spouse never owns the assets, since the assets are owned by the trust. F. Gift Giving Another method for reducing federal estate taxes is a systematic gift-giving program. A physician and his or her spouse may give cash or assets up to $10,000 per year to as many individuals as he or she wishes, without gift tax and without having to file a gift tax return. If the physician is married, and if his or her spouse elects to split gifts, one of them, alone, could make gifts of up to $20,000 per year per donee. If these gifts continue over several years, a considerable sum could be removed from the estate, and the estate taxes would be reduced accordingly. Larger gifts, subject to a lifetime limitation of $1,000,000, effective January 1, 2002, can also be made by the physician and his or her spouse without having to pay a gift tax. The estate tax on the value of these larger gifts is not eliminated because the gift will utilize all or part of the applicable exclusion amount. Nevertheless, estate taxes on the appreciation of the gifted property between the date of the gift and the date of death will be eliminated. Charitable donations during lifetime or bequests at death are another method of reducing the federal estate tax. G. Life Insurance Trust A reduction in federal estate taxes can also be achieved by creating an Irrevocable Life Insurance Trust. The Irrevocable Life Insurance Trust is designed to avoid the inclusion of the insurance proceeds in the insured's estate for estate tax purposes. An Irrevocable Life Insurance Trust can be used to purchase one or more policies of insurance on the life of the creator of the Trust (Grantor) or to receive policies on the Grantor's life which the Grantor owns and is transferring to the Trust. A transfer of existing life insurance policies to an Irrevocable Trust will successfully exclude the proceeds of the policies from the Grantor's estate only if the Grantor survives for three years after the Trust is executed and after the transfer of the policies to the Trust. The Trustees of the Life Insurance Trust will hold legal title to the insurance policies for the benefit of the surviving spouse and the Grantor's descendants. The Trustees will receive the proceeds of the policies upon the Grantor's death, and will use those proceeds to fund a trust which will be substantially identical to the Family Trust previously discussed. H. Asset Protection All of the methods referred to above are techniques for reducing federal estate taxes. Many physicians, however, are concerned about protecting their assets from creditors. The important thing to keep in mind is that to avoid allegations of fraud, any asset protection method should be undertaken well in advance of any difficulties with creditors. Two of the simplest methods of protecting assets from creditors are titling property as tenants by the entireties, that is, property held by husband and wife, together, or making gifts of property to family members. Generally, a creditor of the physician, such as a patient who has been injured due to the malpractice of the physician, cannot reach assets that are not owned by the physician outright. Methods that are somewhat more complicated include transferring property to an irrevocable trust or to an asset protection trust established offshore or in the United States. Although offshore trusts are generally more expensive, they may withstand some of the legal challenges that can plague the newer domestic trusts. Ultimately, however, any asset protection planning should be discussed and considered in conjunction with the physician's estate planning. Inasmuch as asset protection planning may conflict with some estate planning goals, each individual must prioritize his or her goals. The most important thing to remember is that, without proper estate planning, those goals may never be achieved.