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Avoid This Million-Dollar Mistake

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Years ago, the government set in motion a strategy that was designed to eliminate one of the biggest bills you may ever have to pay. But, like a movie villain who uses a 24-hour countdown when five minutes would do the job just as well, the timeline for that strategy extended just long enough that it may now get reversed.

Eight years ago, the estate tax affected anyone with a net worth of $675,000 or more. Under a tax cut passed in 2001, though, that figure rose gradually to $3.5 million this year. Moreover, in 2010, it's slated to go away entirely. But because the 2001 law included a so-called sunset provision, the elimination of estate tax would last only one year -- unless a new law extended its repeal.

Now, with high budget deficits and an ambitious spending program, the current administration has proposed keeping the estate tax at its current level. And although a permanent $3.5 million limit would keep the vast majority of people from dealing with the estate tax for now, it's still something you'll need to keep in mind in order to avoid the prospect of a huge tax bill.

Who pays the most
Of course, the estate tax has the greatest potential impact on the extremely wealthy. Because the estate tax rate is currently 45%, and may sit at that level beyond 2010, the tax is no laughing matter for those with assets above the exemption limit. Consider, for instance, the potential impact on these well-known business entrepreneurs.

Person

Company

Current Value of Shares

Potential Estate Tax

Larry Ellison

Oracle (Nasdaq: ORCL  )

$16.6 billion

$7.5 billion

Jeff Bezos

Amazon.com (Nasdaq: AMZN  )

$6 billion

$2.7 billion

Steve Jobs

Apple (Nasdaq: AAPL  )

$473 million

$211 million

Michael Dell

Dell (Nasdaq: DELL  )

$1.9 billion

$848 million

Steve Wynn

Wynn Resorts (Nasdaq: WYNN  )

$370 million

$165 million

Source: Yahoo! Finance.

These high rates are likely at least one of the considerations that motivate some of the world's biggest philanthropists. Microsoft's (Nasdaq: MSFT  ) Bill Gates, for instance, has given billions to his Gates Foundation, as has Berkshire Hathaway (NYSE: BRK-B  ) chairman Warren Buffett. Because charitable gifts qualify as deductions against the estate tax, each dollar they give essentially saves them $0.45 in tax.

Why it matters to you
Sure, it's hard to feel bad about billionaires having to pay taxes. But a Capgemini study from 2008 counted at least 3 million millionaires in the U.S. -- many of whom might face potential tax liability if the estate tax doesn't get repealed permanently.

In addition, even if you don't have that much money now, you may have a lot more later in life. And if the $3.5 million exemption is not indexed for inflation, then your net worth could easily catch up with the tax over time.

What to do
To avoid paying tax unnecessarily, you have to plan. Although the actual strategies can get complicated, they essentially boil down to making gifts of assets on an ongoing basis during your lifetime in a manner that lets you reduce your taxable estate while preserving your family's overall wealth.

Specifically, some strategies include:

A good estate planning attorney can help you figure out the best strategy.

Although this sounds like bad news for those who had hoped that the estate tax repeal would be made permanent, the proposal still has to get through Congress. There's still a chance that you won't have to worry about this potential tax trap. But in the meantime, it's smart to be prepared for whatever happens.

For more on preserving your wealth, read about:

Estate planning is just part of a successful financial plan in retirement. Get help from the Fool's Rule Your Retirement newsletter, which has tips on how to manage your money to avoid taxes and keep your family financially healthy. Try it out free for 30 days with a trial subscription -- there's no obligation..

Fool contributor Dan Caplinger won't have to worry about estate taxes for a while yet. He owns shares of Berkshire Hathaway. Berkshire Hathaway, Dell, and Microsoft are Motley Fool Inside Value picks. Apple, Amazon.com, and Berkshire Hathaway are Motley Fool Stock Advisor selections. The Fool owns shares of Berkshire Hathaway. Try any of our Foolish newsletters today, free for 30 days. We made no mistake with the Fool's disclosure policy.


Read/Post Comments (2) | Recommend This Article (4)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 09, 2009, at 2:51 PM, emferguson wrote:

    Dan, are you joking? Do you even have any readers who would be affected by this? Please tell me the Walton family isn't paying to have this planted in Motley Fool.

    Sure, I'll plan in case this happens, right after I get done planning in case of equatorial glaciers.

  • Report this Comment On March 09, 2009, at 2:58 PM, ResponsibleMoney wrote:

    To advocate the repeal of the estate tax is ridiculous. It impacts only the top 1% in the US population, and it strongly encourages charitable giving. Their first $3.5 million is tax exempt just like everyone else's, so for the majority of that 1% the effective tax rate is much less than 45%. Neither Warren Buffett nor Bill Gates support repeal of the estate tax, and neither should anyone with half a brain.

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Dan Caplinger
TMFGalagan

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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