The good news is it’s becoming increasingly less likely that you’ll owe estate taxes. However, as these amounts can change at any time, and you may not remember to update your estate plan it is best to have a plan that protects regardless, that way you won’t have to change your estate plan based off of what Congress ultimately decides or makes permanent (if that happens).
The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act (“TRUIRJCA”) was signed into law by President Obama on December 17, 2010. This new law provides sweeping changes to the rules governing federal estate taxes, gift taxes and generation-skipping transfer taxes for the 2010, 2011 and 2012 tax years. The most important point to remember is that last year’s 11th-hour tax changes, though favorable for most, are temporary. After 2012, many provisions are set to snap back to what they were before 2001, and a few even expire this year.
That raises the dreary possibility that in less than two years we will be in a replay of last year’s tax debates, but in the middle of a presidential campaign. Once again tax rates on both pay and investment income will be set to spike, especially for those at the bottom, and the estate tax will revert to a $1 million-per-individual exemption and a 55% top rate.
Here is a summary of what the new law provides for the estates of decedents who die in 2011 or 2012 and some problems created with regard to state estate taxes and generation-skipping trusts:
- Sets new and unified estate tax, gift tax and generation-skipping transfer tax exemptions and rates. For 2011 and 2012, the federal estate tax exemption will be $5 million and the estate tax rate for estates valued over this amount will be 35%. The estate tax has also become unified with federal gift and generation-skipping transfer taxes such that the gift tax exemption and generation-skipping transfer tax exemption will be $5 million each and the tax rate for both of these taxes will also be 35%.
- Offers “portability” of the federal estate tax exemption between married couples. In 2009 and prior years, married couples could pass on up to two times the federal estate tax exemption by including “AB Trusts” or “ABC Trusts” in their estate plan. The new law eliminates the need for AB Trust planning for federal estate taxes by allowing married couples to add any unused portion of the estate tax exemption of the first spouse to die to the surviving spouse’s estate tax exemption. This will effectively allow married couples to pass $10 million on to their heirs free from federal estate taxes with absolutely no planning at all. Note that portability was not applied retroactively to January 1, 2010, and as it now stands is only available for deaths that occured during the 2011 and 2012 tax years. In addition, without AB Trust or ABC Trust planning, state estate taxes may be due in states that collect them. See more on state estate tax issues below.
- State estate tax issues. To date, none of the states that collect a separate state estate tax have adopted portability of the state estate tax exemption between spouses, nor have I heard any discussion about portability becoming available in any state. So while portability may be relied on in states that do not collect a separate state estate tax, AB Trust or ABC Trust planning may still be required in states that collect state estate taxes, particularly in states where the couple has a large estate, the state estate tax exemption is less than the federal estate tax exemption, and state law allows for a separate state QTIP election.
- Generation-skipping trust issues. The generation-skipping transfer tax exemption has not been made portable between spouses, nor have I heard any discussion about this becoming a possibility. Therefore, couples who want to take advantage of passing on up to two times the generation-skipping transfer tax exemption to their heirs in generation-skipping trusts will still need to include AB Trust planning or ABC Trust planning in their estate plans.
With 401(k) accounts compounding and life insurance death benefits thrown into the pot, it’s easier than some think for a working couple to be subject to the estate tax, at least for the next few years. And this tax can be brutal. For every dollar more than $2 million that you leave behind, Uncle Sam will take about 45 cents.
Want to know where you stand? Well, schedule an initial consultation with one of our experienced estate planning attorneys and we will go over your assets and liabilities with you at your initial consultation, outlining exactly what you will be looking at if you were to pass away. If it looks like your heirs will be sharing their bequests with Uncle Sam, don’t fret. There are plenty of things you can do right now to make sure that the prime beneficiary of your life’s hard work isn’t the government.
The unlimited marital deduction enables you to transfer an unlimited amount free of any federal gift or estate taxes to your spouse while you are still alive or at death — provided your spouse is a U.S. citizen. (If not, you can still avoid taxes by taking some further planning steps that are beyond the scope of this article.) You can take advantage of the privilege without using up any of your $1 million gift tax exemption or any of your separate estate tax exemption.
Will my estate have to pay taxes after I die?
It depends. The federal government imposes estate tax at your death only if your property is worth more than a certain amount, depending on the year of death. But there are a couple of important exceptions to the general rule. These rules are complex and untested. Please consult with one of our experienced estate planning attorneys with any questions.
What are the rates for federal estate taxes?
The rates are steep, starting at 35%. The maximum is 55% for property worth over a certain amount.
Are there ways to avoid federal estate tax?
Yes, although there are fewer ways than many people think, or hope, there are.
The most popular method is frequently used by married couples with grown children. It’s called an AB trust, though it’s sometimes known as a ” credit shelter trust,” ” exemption trust,” ” marital life estate trust,” or ” marital bypass trust.” Spouses put their property in the trust, and then, when one spouse dies, his or her half of the property goes to the children – with the crucial condition that the surviving spouse gets the right to use it for life and is entitled to any income it generates. When the second spouse dies, the property goes to the children outright. Using this kind of trust keeps the second spouse’s taxable estate half the size it would be if the property were left entirely to the spouse, which means that estate tax may be avoided altogether.
Unlike a probate-avoidance revocable living trust, an AB trust controls what happens to property for years after the first spouse’s death. A couple who makes one must be sure that the surviving spouse will be financially and emotionally comfortable receiving only the income from the money or property placed in trust, with the children as the actual owners of the property.
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HOW AN AB TRUST WORKS: AN EXAMPLE |
| Ellen and Jack have been married for nearly 50 years. They have one grown son, Robert, who is 39. Ellen and Jack create an AB trust and transfer all their major items of property to it. They name each other as life beneficiaries, and Robert as the final beneficiary. Ellen dies first. The trust automatically splits into two parts. Trust A, which is irrevocable, contains Ellen’s share of the property. Trust B is Jack’s trust, and it stays revocable as long as he is alive.The property in Trust A legally belongs to Robert, but with one very important condition: his father, Jack, is entitled to use the property, and collect any income it generates, for the rest of his life. When Jack dies, the property will go to Robert free and clear.Now let’s take a look at the tax savings: Ellen’s half of the trust property is worth $500,000 when she dies.
At Ellen’s death, in 2000 Taxable estate $500,000 At Jack’s death, in 2004 If Ellen had left all her property to Jack outright, his estate would have been worth $1 million, $150,000 of which would have been taxed.
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Another way to save on estate taxes is to use what’s called a ” QTIP” trust. It enables a surviving spouse to postpone estate taxes that would otherwise be due when the first spouse dies. And there are many different types of charitable trusts, which involve making a sizable gift to a tax-exempt charity. Some of them provide both income tax and estate tax advantages.
Can’t I just give all my property away before I die and avoid estate tax?
No. The government long anticipated this one. If you give away more than $12,000 per year to any one person or non-charitable institution, you are assessed federal ” gift tax,” which applies at the same rate as the estate tax.
Making gifts of less than $12,000, however, can yield substantial estate tax savings. If you give away $12,000 for four years, you’ve removed $48,000 from your taxable estate. And each member of a couple has a separate $12,000 exclusion. So a couple can give $24,000 a year to a child free of gift tax. If you have a few children, or other people you want to make gifts to (such as your sons- or daughters-in-law), you can use this method to significantly reduce the size of your taxable estate over a few years. (The $12,000 amount is now indexed for inflation, and will increase in $1,000 increments in years to come.)
Consider a couple with combined assets worth $1 million and three children. Each year they give each child $24,000 tax free, for a total of $72,000 per year. In seven years, the couple has given away $504,000 and has reduced their estate to $496,000, below the federal estate tax threshold.
Of course, there are risks with this kind of gift-giving program. The most obvious is that you are legally transferring your wealth. Gift giving to reduce eventual estate taxes must be carefully evaluated to see if you can comfortably afford to give away your property during your lifetime.
Some other kinds of gifts are exempt from the gift/estate tax as well. You can give an unlimited amount of property to your spouse, unless your spouse is not a U.S. citizen, in which case you can give away up to $101,000 per year free of gift tax. Any property given to a tax-exempt charity avoids federal gift taxes. And money spent directly for someone’s medical bills or school tuition is exempt as well.
Do some states impose death taxes?
A handful of states impose death taxes. These taxes are of two types: inheritance taxes and estate taxes.
Inheritance taxes are paid by your inheritors, not your estate. Typically, how much they pay depends on their relationship to you. For example, Nebraska imposes a 15% tax if you leave $25,000 to a friend, but only 1% if you leave the money to your child. These rates vary from state to state.
States That Impose Inheritance Taxes
- Louisiana
- New Jersey
- Delaware
- Maryland
- North Carolina
- Indiana
- Michigan
- Pennsylvania
- Iowa
- Montana
- South Dakota
- Kansas
- Nebraska
- Tennessee
- Kentucky
- New Hampshire
State estate taxes are similar to the estate tax imposed by the federal government. Your estate must pay this tax no matter who your beneficiaries are. The good news is that every state except Mississippi, New York, North Carolina, Ohio, and Oklahoma has abolished these taxes, at least in effect. (New York is phasing out its tax.) In the rest, the state takes part of the money that you owe to the feds; it’s a matter for accountants and tax preparers, but doesn’t increase the tax bill.
Can I avoid paying state death taxes?
If your state imposes death taxes, there probably isn’t much you can do. But if you live in two states – winter here, summer there – your inheritors may save on death taxes if you can make your legal residence in the state with lower, or no, death taxes.
Approximately half of our clients have potential taxable estates, so we are very experienced at planning for estate taxes and we have saved our clients literally MILLIONS of dollars.
For further information or to discuss your estate planning issues, we invite you to schedule a free confidential consultation with an experienced northern and southern California estate planning attorney by calling us at 916.999.1376, or filling out our contact us form on our website. The confidential consultation is free.