A Simple Way to Avoid Estate Taxes

QUESTION: My father died a few weeks ago after a long illness. The way his will is worded, he left several thousand dollars that he and my mother had in joint checking and savings accounts to my mother, me and my two brothers. We can’t really afford to hire a lawyer to help us, so we are using an attorney who is a friend of the family and isn’t charging us. I’m turning to you because I think I’ve heard or read that there is a way we can get around the terms of the will so we don’t have a huge tax bill to pay. But this lawyer doesn’t seem to think there is. Am I wrong or is he?--J. U.

ANSWER: As long as the money your father bequeathed is in accounts jointly owned by both of your parents, you can do what you have in mind quite simply.

You and your brothers simply file disclaimers with the court where your father’s estate is being probated. By waiving your right to part of the money, it will all pass to your mother.

She won’t have to pay estate taxes on any of that money because federal law gives married couples an unlimited marital deduction towards estate taxes. As long as all assets are left to the surviving spouse, there is no estate tax--regardless of how large or small the estate.

This is a short-term strategy, though. You and your mother also need to think about the impact of such a waiver on her own estate and the estate taxes the three of you might have to pay later if she leaves both her assets and your father’s to you upon her death. It often happens that a family saves money in the short run by using this unlimited marital deduction but pays more in the long run.

Estates are often even more complicated than they seem. Make sure you and your lawyer talk through all the angles.

Q: On the bus on my way to work the other day I overheard a man say that he is looking into forming a type of company that he thinks will become very popular under tax reform. I thought he called it an EST company, but I may be mistaken. Do you know what he was talking about and why it’s going to become so popular?--E. W.

A: He must have been discussing the so-called S corporation. This is a hybrid form of business organization that combines for small-business owners many of the best features of an ordinary corporation and a partnership.

Basically, the owners of a business organized under S corporation laws get all of the protections against personal liability offered by a regular corporation but pay federal income taxes as individuals rather than as a company. Each shareholder is responsible for reporting a proportionate share of the S corporation’s profits--and is taxed accordingly--once a year, even if the profits aren’t actually distributed to them. The S corporation itself isn’t taxed.

Since the top income tax rate under tax reform will for the first time ever be lower for individuals than for corporations, this type of business set-up is expected to gain popularity. Currently, individual taxpayers pay a top federal income tax rate of 50% and corporations are taxed as high as 46%. Under tax reform, both top rates will drop sharply but the individual rate more so than the corporate rate. By 1988, when the new laws are fully in place, individuals will pay a top rate of 28% and corporations will pay up to 34%.

Only closely held businesses with fewer than 36 shareholders can elect to organize as an S corporation--so called because the section of the tax code creating this business form is called Subchapter S. A married couple counts as one shareholder.