# Sample Estate Tax Calculations and An Illustration of Potential Savings From a Simple Estate Plan

#### by David Miller and Jim Polson*

Here we calculate estate settlement costs and liquidity needs for a couple with a net worth of almost \$2,000,000. The first step is to collect and organize information about their assets and liabilities and how they hold them. It is important to understand that every married couple should plan for two estates—the death of each spouse—with either spouse dying first. It makes a great deal of difference how they own their assets and hold their liabilities. For a more detailed discussion of property ownership go to: Property Ownership.

In Table 1. we see their assets and liabilities organized by ownership. The first column contains a description of the asset or liability and the second column shows the couple’s total values. However, when we look at columns 3 and 4 we see Spouse 1 holds legal ownership to most of the couple’s assets. For example, Spouse 1 is the sole owner of Farm 1, all their automobiles and trucks, the farm machinery, farm livestock, and has a retirement plan. When we look at the ownership for estate tax purposes spouse 1 owns \$1,526,800 of assets while spouse 2 owns only \$323,000 of assets. This lop-sided property ownership is one reason they will pay unnecessary estate taxes unless they put a new estate plan in place.

 Table 1. Asset and Liability Ownership and Values—Current Plan Owned as Sole Proprietorship, Tenants in Common, or Joint with Rights of Survivorship with Spouse. Joint with Rights of Survivorship with Someone Other Than Spouse Asset Total(\$) Spouse 1(\$) Spouse 2(\$) Spouse 1(\$) Spouse 2(\$) Real Estate Farm 1 850,000 850,000 Farm 2 400,000 200,000 200,000 Cash on Hand or in Banks 50,000 25,000 25,000 Automobiles & Trucks 40,000 40,000 Machinery 30,000 30,000 Livestock 20,000 20,000 Crops 20,000 16,800 3,200 Household Goods 20,000 10,000 10,000 Life Insurance 110,000 100,000 10,000 Retirement Plans & Annuities 120,000 120,000 Transfers Subject to Tax Stocks, Bonds & Mutual Funds 40,000 40,000 Other Business Investments Notes, mort. & Acct. Rec. 150,000 75,000 75,000 ASSET TOTALS 1,850,000 1,526,800 323,200 40,000 - Indebtedness 0 0 0 NET WORTH 1,850,000 1,526,800 323,200

### Settlement Costs Under Current Estate Plan

Tables 2 and 3 show what it would cost to settle this couple’s estates under their current property ownership and current wills. Table 2 shows the amount of Ohio and Federal estate taxes for deaths occurring in 2003, while Table 3 combines Estate Settlement Costs, Administrative Costs and debt repayments to show us total estimated liquidity needs. While it is unlikely both spouses will die in 2003, we assumed they would for purposes of estimating estate settlement costs and liquidity needs.

The estate tax implications of the couple’s current estate plan are shown in Table 2. Spouse 1 is assumed to die first with a gross estate of \$1,526,800. For Ohio estate tax purposes the following items are deducted from Spouse 1’s gross estate: life insurance owned by spouse 1 on his own life, administrative expenses, debts, and bequests to charity. Since spouse 1 is leaving all assets to a surviving spouse the marital deduction is equal to the amount that would be taxed, making the Ohio estate tax zero.

Similarly, for the Federal estate, since spouse 1 is leaving all his property to his surviving spouse the marital deduction eliminates all taxes on the estate. This can be a tax trap for the unwary as discussed elsewhere: This Can Be a Tax Trap!

 Table 2. Estimating Estate Settlement Costs for a Married Couple Under Their Current Estate Plan Ohio Estate Tax Estate 1(\$) Estate 2(\$) Gross Estate 1,526,800 1,756,562 - insurance -100,000 -10,000 - admin. expense -53,438 -61,480 - debts 0 0 -charity 0 0 -marital deduction -1,373,362 0 = taxable estate 0 1,685,082 Tentative Tax 0 106,556 - credit -13,900 -13,900 = OHIO ESTATE TAX 0 92,656 FEDERAL ESTATE TAX Gross Estate 1,526,800 1,756,562 - admin. expense -53,438 61,480 - debts 0 0 - charity 0 0 - marital deduction 1,473,362 0 = taxable estate 0 1,695,082 Tentative Fed Tax 0 643,587 - Exclusion Amt. -345,800 -345,800 - State tax credit 0 -38,823 = FEDERAL ESTATE TAX 0 258,964

Since spouse 1 left everything to a surviving spouse there is no state or Federal estate tax. However, in Table 3 we see that administration costs are estimated at \$53,438 and there are no other costs or indebtedness, so total liquidity needs are \$53,438 for the estate of spouse 1.

Passing everything in spouse 1’s estate to the surviving spouse can greatly increase the settlement costs and liquidity needs in the estate of spouse 2. Table 2, third column, shows calculations for the Ohio estate tax and Federal estate tax when spouse 2 dies with all the couple’s property. Ohio estate taxes are \$92,656 and Federal estate taxes are \$258,964. Table 3 shows total liquidity needs of \$413,100, when administrative expenses and debt are added to the Ohio and Federal estate taxes. Thus, total estimated liquidity needs for the two estates are \$466,538.

 Table 3. Total of All Estate Liquidity Needs—Current Plan Estate 1(\$) Estate 2(\$) Administration Expense 53,438 61,480 Ohio Estate Tax 0 92,656 Federal Estate Tax 0 258,964 SUBTOTAL 53,438 413,100 + Debts Payable at Death 0 0 = TOTAL LIQUIDITY NEEDS 53,438 413,100 TOTAL LIQUIDITY NEEDED FOR BOTH ESTATES 466,538

### An Alternative Estate Plan

Tables 4, 5 and 6 contain information about an “ Alternative Estate Plan.” A quick comparison at the bottom line in Table 6 shows more than a \$330,000 reduction in estate liquidity needs for the two estates. What did they do to reduce estimated settlement costs by more than \$330,000?

#### Principle One—Balance the Estates

One of the basic principles of reducing estate taxes and settlement costs for larger estates, hence maximizing the residual to the heirs, is to balance the estates of the spouses. In this case, that simply means transferring the ownership of some property to spouse 2 while they are both living. Table 4 shows how the property is owned after changing the deeds to the farms, changing the ownership of the bank accounts and re-titling the vehicles to either sole ownership or as tenants-in-common. This was accomplished by making gifts of property from spouse 1 to spouse 2. Currently there are no restrictions or taxes on transfers between husband and wife, so it was simply a matter of changing legal ownership, for which there are some relatively minor attorney and filing costs.

The reason balancing the estates is so important is that no one ever really knows with certainty which spouse will die first. In our example, if spouse 2 died first, spouse 1 might find it quite difficult to reduce the estate enough to avoid Federal estate taxes. If the estates are balanced while both spouses are alive it makes principle two (below) much easier to implement.

#### Principle Two—Bypass the Second Estate

A second principle is to bypass the second estate. In our example, this simply meant that when the first spouse dies they do not leave much, if any, property outright to the surviving spouse. If the surviving spouse needed or wanted to use the property that can usually be taken care of while spouse 1 is still alive by creating a marital deduction trust credit shelter or life estate. The use of either the credit shelter trust or the life estate requires that they be set up prior to the death of the first spouse. Either instrument could allow the surviving spouse to use the assets formerly owned by the deceased spouse and earn income from them. However, spouse 1’s assets would NOT be included in spouse 2’s estate when spouse 2 dies.

In our example, implementing the second principle was a two-step process. First, the couple had to change the ownership of any property they owned jointly “with rights of survivorship.” That was necessary because any property spouse 1 owned “with rights of survivorship” with spouse 2 would automatically go to spouse 2 at death regardless of what spouse 1’s will, trust or life estate says. Here we were trying to keep most of the couple’s assets out of the second estate so it was necessary to change the ownership of any survivorship property. In Table 4, note the heading at the top of columns 3 and 4 is “Owned as Sole Proprietorship or Tenants in Common with Spouse,” while in Table 1 the heading included “survivorship” property.

Note, changing property ownership from joint tenants with rights of survivorship to sole ownership or tenants-in-common is not a general recommendation for all situations. Some couples may want to own all or a portion of their assets as survivorship property. For a more detailed discussion of property ownership click here: Property Ownership.

The second step in implementing principle two, was for the couple to rewrite their wills or trusts so they did not leave much, if any, property to the surviving spouse. In our example, spouse 1 did not leave any property to the surviving spouse (spouse 2). If needed, trusts and life estates could have been set up to care for the surviving spouse, without leaving property to them that will be taxed in their estates. For more details see: Trusts or Life Estate.

#### Principle Three—Reduce Both Taxable Estates

A third principle is to reduce the size of the taxable estates of the two spouses. Normally one might begin by making substantial gifts to heirs or charity. However, in our example we did not make any gifts, but we moved ownership of the life insurance policies to an irrevocable trust, removing them from both taxable estates. In Table 4 on the Life Insurance line it says, “Insurance is put into trust, not in estates.”

 Table 4. Asset and Liability Ownership and Values—Alternative Plan Owned as Sole Proprietorship or Tenants in Common with Spouse. Joint with Rights of Survivorship with Someone Other Than Spouse Asset Total\$ Spouse 1\$ Spouse 2\$ Spouse 1\$ Spouse 2\$ Real Estate Farm 1 850,000 425,000 425,000 Farm 2 400,000 200,000 200,000 Cash on Hand or in Banks 50,000 25,000 25,000 Automobiles & Trucks 40,000 20,000 20,000 Machinery 30,000 15,000 15,000 Livestock 20,000 10,000 10,000 Crops 20,000 10,000 10,000 Household Goods 20,000 10,000 10,000 Life Insurance 110,000 01 Retirement Plans & Annuities 120,000 120,000 Transfers Subject to Tax Stocks, Bonds & Mutual Funds 40,000 40,000 40,000 Other Business Investments Notes, mort. & Acct. Rec. 150,000 75,000 75,000 ASSET TOTALS 1,850,000 950,000 790,000 - Indebtedness 0 0 0 NET ESTATE 1,850,000 950,000 790,000 1/ Insurance is put into an irrevocable trust during their lifetime, so it is not in either estate.

### Estate Settlement Costs Under An Alternative Plan

The primary result of the alternate estate plan was a reduction in estate settlement costs for the two estates of slightly more than \$330,000. The alternate plan was a very simple plan which worked very well for estates of this size. Slightly different methods would be used for smaller and larger estates and for people with different objectives. The estate cost savings, if any, would also be different.

 Table 5. Estimating Estate Settlement Costs for a Married Couple Under An Alternative Estate Plan Ohio Estate Tax Estate 1(\$) Estate 2(\$) Gross Estate 950,000 790,000 -insurance 0 0 -admin. expense -38,000 -31,600 -debts 0 0 -charity 0 0 -marital deduction 0 0 =taxable estate 912,000 758,400 Tentative Tax 52,440 41,688 -credit -13,900 -13,900 = Ohio Estate Tax 38,540 27,788 Federal Estate Tax Gross Estate 950,000 790,000 -admin. expense 38,000 31,600 -debts 0 0 -charity 0 0 -marital deduction 0 0 = taxable estate 912,000 758,400 Tentative Fed Tax 311,480 251,408 -Exclusion Amt. -345,800 -345,800 -State tax credit -14,136 -10,402 =Federal Estate Tax 0 0

The alternate plan was not all smooth sailing. Under the current estate plan there was no Ohio or Federal estate tax when spouse 1 died. Under the alternate plan, when Spouse 1 died, there was \$38,540 of Ohio tax and no Federal tax, as seen in Table 5. That compares with no Ohio tax and no Federal tax under their current plan. The additional \$38,540 of tax at the first death may seem like a big bill, and it is a lot of money, but when spouse 2 died under the current plan estate settlement costs were \$466,538 versus \$135,928 under the alternate plan as shown in Table 6. In this instance, it definitely paid to incur some estate settlement costs when spouse 1 dies in order to greatly reduce the estate settlement costs when spouse 2 died. If the deaths were likely to occur 30 years apart, the right answer would not be as evident.

 Table 6. Total of All Estate Liquidity Needs Current Plan Alternate Plan Estate 1(\$) Estate 2(\$) Estate 1(\$) Estate 2(\$) Administration Expense 53,438 61,480 38,000 31,600 Ohio Estate Tax 0 92,656 38,540 27,788 Federal Estate Tax 0 258,964 0 0 SUBTOTAL 53,438 413,100 76,540 59,388 + Debts Payable at Death 0 0 0 0 = TOTAL LIQUIDITY NEEDS 53,438 413,100 76,540 59,388 TOTAL LIQUIDITY NEEDED FOR BOTH ESTATES 466,538 135,928

The alternate plan also illustrates the importance of having a carefully considered, coordinated and comprehensive estate plan. Many people attempt do-it-yourself estate planning and end up with only part of a plan. For example, if our family implemented principle one “ balancing the two estates,” but not principle two “ Bypass the Second Estate,” all the property would still end up in the surviving spouse’s estate and nothing would be gained. Similarly if they implemented principle two, but not principle one they would still pay an excessive amount of tax, especially if spouse 2 died first. However, there would be some benefit of implementing principle three “ Reduce Both Taxable Estates,” even if nothing else was done.

It is also much to a couple’s advantage to put their estate plans into place when both spouses are alive. After the first spouse dies the survivor can still reduce their estate and the associated settlement costs, but the alternatives available are much more limited than when both spouses are alive.

The example above was intentionally simple to illustrate the large potential savings from implementing a very basic estate plan. In no particular order, here are some other estate planning tools that might reduce taxes even further. Most of these would fall under principle 3, “Reduce Both Taxable Estates.”

Estates may be eligible to have their assets valued at below-market values under one or more federal and state programs. For more detail click on the following links:

A “ disclaimer” is a method for a surviving spouse or other heir to do some post-death estate planning by not accepting property that is left to them. They simply disclaim all or part of it and it goes to others. When a surviving spouse disclaims, it falls under principle two, “Bypassing the Second Estate.” However, anyone may disclaim property left to them that they do not want or need. For more information on disclaimers click here: Disclaimer.

Persons with substantially larger or smaller estates and persons with different objectives will undoubtedly use a different mix of tools. The simple example illustrated here shows that there are many different tools and many different ways of using them to accomplish different people’s objectives. A key point here is that almost all of us would benefit from working with individuals who have training and experience in estate planning. Estate planning is simply too complex for most of us to choose and implement the best tools on our own.

*District Specialist, Farm Management, East District, and District Specialist, Farm Management, Northeast District (Emeritus), Ohio State University Extension.

November 2003

All educational programs conducted by Ohio State University Extension are available to clientele on a nondiscriminatory basis without regard to race, color, creed, religion, sexual orientation, national origin, gender, age, disability or Vietnam-era veteran status.

Keith L. Smith, Associate Vice President for Ag. Adm. and Director, OSU Extension.

TDD No. 800-589-8292 (Ohio only) or 614-292-1868

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