The estate tax, or “death tax,” is a hot topic in estate planning. However, today, the estate tax does not impact most people.
For much of history, the estate tax had a relatively low exemption and a high top tax rate. For instance, from 1942 to 1976, the exemption was only $60,000, and the top tax rate was a whopping 77%. The exemption did not eclipse $1,000,000 until 2002. Because of the low exemption and high tax rate, the estate tax was an estate planning issue for many people.
Traditionally, the goal of estate tax planning has been to fully utilize the first-to-die spouse’s applicable exemption, which was non-transferable, while deferring all estate taxes until the death of the second spouse using the marital deduction. In order to achieve this goal, a couple was forced to weigh estate tax concerns against asset protection.
The American Taxpayer Relief Act of 2012 (“ATRA”) had a major impact on the federal estate tax, raising the exemption to $5,120,000 for 2012, and indexing the amount for inflation. Hence, the estate tax exemption was $5,250,000 for 2013, $5,340,000 for 2014, $5,430,000 for 2015, and $5,450,000 for 2016. The estate tax rate is 40%.
One of the most important feature of ATRA is “portability.” In short, if the first-to-die spouse does not use all of his or her exemption, the excess, which is called the deceased spousal unused exclusion (DSUE), may be transferred to the second spouse. For example, if the first spouse died in 2014 and has an estate of $1,000,000, and the second spouse died in 2015, the second spouse’s exemption would be $9,770,000 (the combination of the first spouse’s unused – “ported” – exemption of $4,340,000 and the second spouse’s exemption of $5,430,000). In sum, this means that, in most situations, a couple needs to have roughly $10,000,000 in assets for the estate tax to be an estate planning issue. It is critical to note that the first-to-die spouse’s DSUE must be claimed with the IRS and ported to the second spouse; it is not an automatic transfer. It is also important to note that remarriage can change this formula.
The estate tax cannot be understood without a discussion of the gift tax. The gift tax is a federal tax that has annual and lifetime aspects. Annually, the gift tax applies to any amount above the exemption for that particular year. For 2014, 2015, and 2016 the gift tax exemption is $14,000 per recipient. In other words, an individual may give as many $14,000 gifts to as many individuals as he or she wishes and not incur gift tax liability. Notably, a married couple may double the gift tax exemption to $28,000 per recipient. The gift tax rate is 40%.
Importantly, there are exceptions to the gift tax. An individual may give the following gifts without counting against the gift tax exemption: charitable gifts, gifts to a spouse, gifts for educational expenses (as long as directly paid to the institution, and for tuition only), and gifts for medical expenses (as long as directly paid to the provider).
The estate tax and the gift tax are linked together due to the unified credit. In brief, the unified credit is one exemption for both taxes. The unified credit is the same exemption referenced above, $5,450,000 for 2016. It is important to understand the concept of the unified credit because of how it may be used. In short, an individual who incurs gift tax liability in any given year can choose to pay the gift tax or have the amount of the liability subtracted from his or her unified credit. However, it is important to understand that any gift tax liability subtracted from the unified credit will accordingly reduce the individual’s estate tax exemption. For example, an individual who dies in 2016 and gave away $1,000,000 over the gift tax annual exemption during the course of his or her lifetime will have his or her $5,450,000 unified credit reduced by $1,000,000, and only have $4,450,000 remaining as an estate tax exemption.
As of January 1, 2005, no state estate tax exists for the State of Missouri.
Importantly, the estate tax, gift tax, and related taxes change every year, and it is especially important to consult with an attorney or Certified Public Accountant (CPA) about any transfer tax issues associated with your situation.
If you have additional questions about the estate tax and gift tax or are ready to have an estate plan prepared, call or come visit with the estate planning attorneys at the Paul Law Firm. Consultations are always free!