Mr. Walters: "I'm looking for my wife -- she died a few years ago."
Mrs. Johnson: "Not now, she's upset with you. She heard you gave more money to the IRS than to your children, grandchildren and favorite charities combined."
Walters: "Oh, that's estate tax. The IRS collects it after the last spouse dies. I actually had our heirs' and charities' best interests in mind -- my CPA recommended an estate tax reduction strategy after my wife passed away. But it would have cost more than $15,000.
We had already gifted $1 million each -- the IRS allowed that level of gifting with no tax consequences. This new strategy had fees going to the CPA, an estate tax attorney and an appraiser. Why spend that money when I could time my death -- pass away in 2010 when there's no estate tax and save $15,000 that can go to heirs and charities."
Johnson: "But you died yesterday. It's 2011, and the IRS gets almost 55 percent of your $5 million estate. That's $2.75 million to the IRS and only $2.25 million left to others. Your wife said you also gave a 'bonus' to the IRS called GST tax -- what's that?"
Walters: "Generation skipping transfer tax. The IRS gets 55 percent for funds transferred directly to grandchildren. So the IRS is getting even more. I can see why my wife is upset, but I just wanted to keep things simple and save $15,000."
Johnson: "It is simple. The IRS takes more than 60 percent; the rest of the world gets less than 40 percent. Luckily, I didn't need to worry about the IRS."
Walters: "Why not?"
Johnson: "My husband also died a few years ago, but we had already looked into this estate tax situation back in 2005. We didn't need to do anything. There was a declining estate tax rate and the amount of property that would be exempt from estate tax increased each year.
We didn't have to worry about estate tax when the first spouse died because an unlimited amount of property could be passed to the surviving spouse without tax. And there would be no estate tax in 2010, but the old 55 percent maximum tax rate and $1 million exemption amount returned in 2011.
My husband and I only had about $1.5 million total, and we'd get to exempt $1 million each from estate taxes -- our kids would get to keep everything."
Walters: "Was $1.5 million enough for retirement?"
Johnson: "Well, it was tied up in retirement plans. Cash was tight, but once my husband passed away in 2007, I had $1 million from life insurance."
Walters: "The life insurance proceeds went into an ILIT?"
Johnson: "A what?"
Walters: "ILIT -- an irrevocable life insurance trust. It holds life insurance policies and removes the proceeds from estate taxation. The surviving spouse lives off the funds within IRS guidelines. When the surviving spouse dies, there's no estate tax when the funds go to your heirs."
Johnson: "And with no ILIT?"
Walters: "You pay the IRS if your estate is over your $1 million exemption, since it's after 2010."
Johnson: "We had $1.5 million, but the bull market from 2008 to 2010 nearly doubled it to $2.8 million. Also, the insurance proceeds grew to $1.8 million. That's $4.6 million total."
Walters: "And your house?"
Johnson: "It was my parents' house; I didn't pay for it."
Walters: "You have to pay estate tax on the value of your house and all of your property as of the date of your death."
Johnson: "Yikes! With our house, jewelry, cars, furs and other personal belongings, that's another $2 million. So my estate is $6.6 million, and we didn't do any estate planning."
Walters: "Well, there's bad news and good news. Looks like the IRS will get about half of your estate."
Johnson: "What's the good news?"
Walters: "If I tell my wife about your situation, maybe she won't be as upset with me."
Robert N. Greenberger, CPA, PFS, is a tax principal at Tauber & Balser P.C. With more than 20 years of professional experience, he has assisted companies, business owners and high-net-worth individuals with complex income tax and estate tax strategies. He is on the board of the Atlanta Estate Planning Council and has spoken about many tax topics. Reach him at (404) 814-4949 or email@example.com.