One of the top priorities that you are going to have when you begin to evaluate your legacy is to determine the extent of your exposure to the estate tax. There are those who say that you don’t have to worry about the estate tax because it is only imposed on “the rich,” but this is a gross oversimplification. Bill Gates or Warren Buffett rich is one thing, but the estate tax exclusion is not $1 billion.
In fact, though it stands at $5 million right now, if the laws remained unchanged the exclusion is going to be reduced to just $1 million in the beginning of 2013. A Spectrem report states that there were 8.4 million households in the United States with assets that exceeded $1 million in 2010, and this doesn’t include the value of their primary places of residence. And in New Jersey we have a separate state level estate tax with a much smaller $675,000 exemption that must be planned for.
That is a pretty significant number of people who will be exposed to the New Jersey estate tax and possibly the IRS estate tax, which carries a 35% rate at present with an increase to 55% scheduled for January 1st, 2013. If you and your spouse worked hard all of your lives, made some good investments, inherited some resources and planned ahead intelligently you may well have assets that exceed $675,000/$1 million without considering yourself to be rich at all.
If your children do have to pay the estate tax and they then leave that money to your grandchildren, it will be taxed yet again, and this cycle can repeat until only the exempt amount exists. This can be prevented through the creation of a generation-skipping trust.
On the surface it is self explanatory: you make your grandchildren rather than your children the beneficiaries of the trust. They assume ownership of the assets in the trust after the passing of your children and the generation skipping transfer tax is applicable. But your children may benefit from the trust while they are living, so in effect the funds are passed through two generation but they are taxed a single time.
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