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Health & Fitness

Estate, Gift, and Generation-Skipping Transfer Taxes

Estate, Gift, and Generation-Skipping Transfer Taxes

Pursuant to the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (2010 TRA), the government does not tax an estate (the entire value of all assets deemed owned or controlled by a decedent pursuant to IRC §§2031 and 2033, and the inclusion provisions of IRC §2035–2046) unless its value is greater than $5.12 million (the 2012 federal estate tax exemption). This exemption, called the applicable exclusion amount, corresponds to a unified tax credit. Without congressional action, starting January 1, 2013, this federal estate tax exemption will automatically decrease to $1 million. The lifetime gift tax exemption presently is the same value as the estate tax exemption and also will revert back to $1 million on January 1, 2013. This temporary five-fold exemption allows for unprecedented estate planning opportunities, especially as related to trusts. 

The government additionally imposes a generation-skipping transfer tax (GSTT) on the transfer of wealth to a second-generation (or greater) heir. The 2010 TRA reinstated this tax after a short, unintended hiatus with an exemption of $5.12 million in tax year 2012. Without Congressional action, in 2013 it too will revert back to its previous exemption amount of $1 million but with an adjustment for inflation. These figures are for US citizens. Different exemptions apply to non-US citizens; thus special provisions are necessary for a trust with a foreign beneficiary.

Federal Estate Tax Rates 

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For the year 2012, the estate tax rate is a flat 35 percent. Without Congressional action, the federal estate tax rates will revert back to the rates pursuant to IRC §2001(c), before it was amended by the Economic Growth and Tax Relief Reconciliation Act of 2001 (2001 TRA) and the subsequent 2010 TRA. The pre-2001 TRA law on estate taxes scheduled yearly increases in the estate tax exemption up to the year 2006 exemption of $1 million. This means that when the 2010 TRA sunsets at the end of 2012, the tax rates will be pursuant to IRC §2001(c) at 2006’s marginal rates. These marginal rates begin near 39 percent and increase to a rate of 55 percent. Estate values between $10 million and $17.184 million are subject to an additional 5 percent surtax, for a top rate of 60 percent.

State Estate Tax Rates 

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In 2005, the 2001 TRA decoupled the federal estate tax benefits given to states. Until then, individual states were entitled to a portion (called a “sponge” tax) of the federal estate tax. Since 2005, numerous states have enacted their own stand-alone state estate taxes with varying rates and exemption amounts. State estate tax exemptions range from a complete lack of estate tax, most notably in Florida, to lower exemptions in Ohio ($338,333) and New Jersey ($675,000), to Hawaii’s and North Carolina’s present $5,120,000 exemption. Many states have $1 million or $2 million exemptions. The federal estate tax form (IRS Form 706) presently allows for a credit for the state estate taxes a taxpayer pays, and will continue to do so when the 2010 TRA sunsets. In addition, each state’s computation of its estate tax varies. Therefore, an estate planner must carefully determine and examine the state estate taxes of the client’s domicile, as well as those of any other state where the client owns assets, most notably real property. The client may need to consider domicile forum shopping in this case or convert the title of such real property to a limited liability company or trust in the client’s domicile state to avoid an additional (ancillary) probate estate and potential tax. 

Estate Tax Portability

According to the present portability provision of IRC §2001(c), as amended by the 2010 TRA, for clients dying in year 2012, in addition to their unused exemption, the client’s estate may utilize any federal estate tax exemption amount not used in a prior-deceased spouse’s estate. The fiduciary of the first spouse’s estate must elect to preserve this unused portion on that estate’s IRS Form 706 in order for it to be available for the surviving spouse’s estate. The portability provision is due to sunset along with the 2010 TRA at the end of 2012.

The estate tax portability provision is meant to assist clients whose estate planning was not adequately designed to use both spouses’ exemptions. For instance, when all assets pass to the surviving spouse through a simple “I love you” will, or when all assets are held in survivorship, a single estate tax exemption applies to the total asset values (from both spouses) that are included in the second spouse’s gross taxable estate. Thus, the first spouse’s exemption is wasted. The portability provision fixes that; however, the first spouse’s unused exemption is applied to the value of assets at the surviving spouse’s later death, not at the presumably lower values existing at the time of the first spouse’s death. If the value of these assets grows, the surviving spouse can exempt the first spouse’s assets and their growth by utilizing revocable trusts with proper tax formulas to shelter the assets and appreciation in a credit shelter trust for the benefit of the surviving spouse and heirs. The portability provision creates a safety net for those who fail to properly plan, but it may still result in a married couple paying greater estate taxes.[1] Even if Congress chooses to reinstitute the portability provision, it is still better for clients with appreciating assets and taxable estates to instead use revocable trusts with estate tax formulas. Doing so will utilize both spouses’ federal estate tax exemptions and capture the appreciation of the first spouse’s sheltered assets.

 

 

[1] There is another more complicated means to use both spouse’s estate tax exemption and still capture appreciation in the wealth of the first spouse by using reverse qualified terminal interest property (QTIP) trusts.

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