Estate Planning in 2011, 2012 and Beyond
Although the federal estate tax was officially repealed on January 1, 2010, President Obama signed the Tax Relief Act into law on December 17, 2010, which reinstates the estate tax retroactively back to January 1 and also set new rules for the estates of decedents who die in 2011 and 2012. This law, however, is set to sunset on December 31, 2012, which means that in 2013 the estate tax laws will revert back to the laws that were in effect in 2001/2002. As such, do not use this uncertainty as an excuse to put off making or updating your estate plan, because the consequences of not having an estate plan, or having an outdated estate plan, are simply too great. The beauty of estate planning is that estate plans can be made flexible enough to change as your life and the laws change.
The other thing to consider is where you live since currently a handful of states and the District of Columbia collect an estate tax at the state level and seven states collect a state inheritance tax (Maryland and New Jersey are the only two states that collect both types of taxes): Unfortunately, no one can predict the future and if and when someone will become mentally incapacitated or when someone will die. If you do not have a disability plan, then you and your property may end up in a court-supervised guardianship or conservatorship, and if you do not have an estate plan, then your loved ones will not know what you really wanted and your property may go to someone or somewhere that you would not have chosen had you taken the time to make a plan. Be smart – make an estate plan, or update your old and outdated estate plan, to protect you and your loved ones.
Taxes That you Should Be Aware of!
Gift Tax
The gift tax is a tax on the transfer of property by one individual to another while receiving nothing, or less than full value, in return. The tax applies whether the donor intends the transfer to be a gift or not. The gift tax applies to the transfer by gift of any property. You make a gift if you give property (including money), or the use of or income from property, without expecting to receive something of at least equal value in return. If you sell something at less than its full value or if you make an interest-free or reduced-interest loan, you may be making a gift. The gift tax is probably the most ignored tax that can affect an estate. Currently the federal tax code exempts up to $13,000 per year in gifts made by any individual to any number of other individuals – this is referred to as the annual exclusion from gift taxes. Once you make a gift over $13,000 in any given year to the same person, you’ll be making a taxable gift and you’ll incur a gift tax. However, instead of paying the tax immediately, currently the federal tax code gives you a lifetime gift tax exemption of $5,000,000 that can be used to offset your taxable gifts. Think of the gift tax exemption as a “$5,000,000 coupon” against the application of the gift tax.
Estate Tax
The Estate Tax is a tax on your right to transfer property at your death. It consists of an accounting of everything you own or have certain interests in at the date of death. The fair market value of these items is used, not necessarily what you paid for them or what their values were when you acquired them. The total of all of these items is your “Gross Estate.” The includible property may consist of cash and securities, real estate, insurance, trusts, annuities, business interests and other assets.
The table compares current rates and exemptions with those from 2009 and those scheduled to take effect next year unless Congress changes the law.
| Year | Lifetime Gift Tax Exemption | Total Gift and Estate Tax Exemption | Generation Skipping Tax (GST) Exemption | Gift, Estate, and GST Taxes/Top Rates |
|---|---|---|---|---|
| 2009 | $1 million | $3.5 million | $3.5 million | 45% |
| 2010 | $1 million | Unlimited | Unlimited | 35% |
| 2011 | $1 million | $1 million | $1 million | 55% |
For example, let’s assume that this year you decide to gift $113,000 to your son for a down payment on a house. For gift tax purposes, the first $13,000 will have no consequence, but the next $100,000 will be considered a taxable gift. Thus, once the gift is made, instead of having a $5,000,000 gift tax coupon, you’ll have a $4,900,000 coupon remaining.
Taxable gifts made during the course of the year need to be reported on IRS Form 709 (PDF), United States Gift (and Generation-Skipping Transfer) Tax Return, which must be filed on April 15 of the year following the year in which the gift was made.
Two states still currently impose their own gift tax in addition to the federal gift tax: Connecticut and Tennessee. Louisiana abolished its gift tax as of July 1, 2008, and North Carolina abolished its gift tax as of January 1, 2009.
Estate Taxes – Federal Estate Taxes and State Estate Taxes
For decedents who die during 2010, 2011 or 2012, the federal estate tax applies to estates that are valued at more than $5,000,000, which is referred to as the federal estate tax exemption. Current law provides that the federal estate tax exemption will decrease from $5,000,000 to $1,000,000 on January 1, 2013.
| Year | Estate Tax Exemption | Top Estate Tax Rate |
|---|---|---|
| 1997 | $600,000 | 55% |
| 1998 | $625,000 | 55% |
| 1999 | $650,000 | 55% |
| 2000 | $675,000 | 55% |
| 2001 | $675,000 | 55% |
| 2002 | $1,000,000 | 50% |
| 2003 | $1,000,000 | 49% |
| 2004 | $1,500,000 | 48% |
| 2005 | $1,500,000 | 47% |
| 2006 | $2,000,000 | 46% |
| 2007 | $2,000,000 | 45% |
| 2008 | $2,000,000 | 45% |
| 2009 | $3,500,000 | 45% |
| 2010 | $5,000,000 or $0 | 35% or 0% |
| 2011 | $5,000,000 | 35% |
| 2012 | $5,000,000 | 35% |
| 2013 | $1,000,000 | 55% |
When preparing or updating your estate plan, you will need to have a basic understanding of the different types of taxes that can affect your estate – gift taxes, estate taxes, inheritance taxes, generation skipping (or GST) taxes, and income taxes.
State Inheritance Taxes
As of January 1, 2011, there are seven states that collect a separate inheritance tax, which is a state tax imposed on certain beneficiaries who receive a deceased person’s property: Indiana, Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. In all of these states assets passing to the deceased person’s surviving spouse and charity are exempt from the inheritance tax, while in several of these states – Iowa, Kentucky, Maryland and New Jersey – assets passing to the deceased person’s descendants are also exempt. Note that currently Maryland and New Jersey are the only two states that assess both state estate taxes and state inheritance taxes.
State laws change frequently, so it is best to consult with a qualified estate planning attorney in your state to determine if your assets will be subject to a state estate tax or a state inheritance tax after you die. Also, if you own personal effects or real estate outside of your home state and the other state has an estate tax or an inheritance tax, then there may be an estate tax or an inheritance tax due on your out of state property after your death.
Generation Skipping Taxes
For decedents dying in 2010, 2011 and 2012, the generation skipping transfer tax (GST) applies to transfers of more than $5,000,000 that “skip” one or more generations. “Skip” refers to either a transfer that is made to a relative who is two or more generations below your generation (for example, a grandparent to a grandchild), or to a non-relative who is more than 37 ½ years younger than you. Current law provides that the GST exemption will decrease from $5,000,000 to $1,000,000 on January 1, 2013.
The majority of the states that still impose their own separate state estate tax also assess a separate generation skipping tax. However, as with state estate taxes and inheritance taxes, it is best to consult with a qualified estate planning attorney in your home state to determine if your state has its own generation skipping tax.
Income Taxes
For deaths occurring in 2010, the decedent’s heirs will have the choice of subjecting the estate to federal estate taxes or applying the modified carryover basis regime. What modified carryover basis means is that instead of the beneficiaries of an estate or trust receiving an asset with a full step up in basis to the date death fair market value, the beneficiaries will receive the lesser of the fair market value of the property or the decedent’s original basis which can be adjusted following specific basis adjustment rules. Depending on the modified carryover basis of an asset, the beneficiaries may owe capital gains taxes when the inherited asset is later sold.
Aside from the new basis rules, during the course of settling an estate or trust after someone dies, the estate or trust assets will undoubtedly earn interest until they can be distributed out of the estate or trust to the ultimate beneficiaries. Aside from this, certain types of accounts have built in income tax consequences referred to as “income in respect of a decedent” (or IRD) when the owner dies, such as non-Roth IRAs, 401(k)s, and annuities. Thus, while many estates and trusts may not be affected at all by gift, estate, inheritance, or generation skipping taxes, the majority will be affected in some way or another by income taxes.