Estate and Gift Taxes
For 2011 and 2012, the estate and gift taxes will affect only the wealthiest estates. Each individual has a $5 million exemption for cumulative lifetime and testamentary (at death) transfers.
The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 that President Obama signed on December 17, 2010 revised the estate and gift taxes for a two year period only. There is considerable uncertainty right now in the estate planning world about what will happen after 2012. Without Congressional action, the current estate, gift, and generation-skipping tax law will “sunset” on December 31, 2012 and the estate, gift, and generation-skipping tax law will revert back to the laws prior to the Bush-era tax cuts.
Properly advising a client on these estate and gift tax changes and issues is an extremely important part of estate planning and trust administration.
Annual gift tax exclusion amount
The annual gift tax exclusion is the amount that can be given away by a taxpayer in any one year to any one recipient without having any federal gift tax consequences. For 2011, the annual gift tax exclusion is $13,000. Donors may gift property valued up to this amount without using their lifetime gift tax exemption amount. The exclusion applies to the fair market value of the gift at the time of the gift. This gift does not have to be reported to the IRS. A married couple has a combined $26,000 annual exclusion for each person to which they wish to give. Other exclusions, which are not subject to the $13,000 annual limit, can be used for direct payments for medical expenses and college tuition.
Lifetime gift tax exemption
The lifetime gift tax exemption is the amount that can be given away by a donor over his or her entire lifetime to any number of people that will be free from gift taxes. For 2011, the lifetime gift tax exemption is $5 million. All gifts over the annual exclusion (see above) will count against this lifetime exemption. For example, your gift (or gifts) valued at $14,000 in a single year to an individual will fully utilize your $13,000 exclusion amount and will consume $1,000 of your life time gift tax exemption. All gifts must be analyzed under these two important tax rules. The lifetime exemption is cumulative, so care should be taken to track how much you have used. Gift tax returns should be filed for all gifts above the annual exclusion, even when no gift tax is due, so as to trigger the running of the statute of limitations against an IRS challenge.
Since the value of lifetime gifts is subtracted from the federal estate tax exemption, gift tax and estate tax planning go hand and hand and should be discussed as part of a comprehensive estate planning process.
Federal Estate Tax Exemption
The federal estate tax exemption is the amount of your assets that you can transfer tax free at your death. For 2011, the federal estate tax exemption amount for each individual is $5 million. This amount is reduced by the value of all exempt lifetime gifts. The more exempt gifts you have made during life, the less estate tax exemption you have at death.
Under current law, a surviving spouse can use the unused exemption of the first spouse to die for a possible $10 million estate tax exemption. This “portability of the spousal exemption” can only be utilized if the first spouse dies during 2011 or 2012. The executor of the deceased spouse’s estate must also file a timely estate tax return and make an election for portability. These laws allowing portability will sunset on December 31, 2012, without further Congressional action.
Marital deduction
Gifts to your spouse—whether during your lifetime or at your death by will or trust—are not counted when calculating estate taxes; the value of these gifts is “deducted” from your gross estate.
Charitable deduction
Gifts to charities, educational institutions and religious organizations and institutions are deducted from your gross estate for estate tax purposes. Utilizing these deductions is an excellent way to reduce the value of your estate below the taxable threshold. Individuals and couples facing significant estate taxes, often because of highly appreciated property, sometimes set up charitable remainder trusts to provide income to them during life, while allowing them to deduct the appreciated, fair market value of the “remainder” gift that passes to the charity at their death, thereby minimizing both capital gains and estate taxes.
Generation-skipping tax (GST)
A third type of transfer tax, the generation-skipping tax targets gift transfers to grandchildren and other individuals more than one generation below the donor. The tax is imposed at the time of a distribution or transfer from the donor or their trust to the recipient. Like the gift tax, each individual has a lifetime GST exemption to shield a certain amount of assets from the tax. For 2011 and 2012, GST exemption is $5 million, which will touch only the wealthiest individuals who transfer or distribute (directly or in trust) to their grandchildren. Because complications can arise when designing trusts with grandchildren as beneficiaries, understanding how to allocate the donor’s GST exemption is an important part of the estate planning process for estates in the taxable “danger zone.”