As the old saying goes, you can’t cheat death or taxes. In fact, you might still owe taxes after you die. One of these taxes is the federal estate tax. Generally, this is a transfer tax that may be imposed on property you own at your death. The sweeping changes of the 2017 Tax Cuts […]
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As the old saying goes, you can’t cheat death or taxes. In fact, you might still owe taxes after you die. One of these taxes is the federal estate tax. Generally, this is a transfer tax that may be imposed on property you own at your death.
The sweeping changes of the 2017 Tax Cuts and Jobs Act (TCJA) ushered in a number of significant changes for estate taxes and planning. Beginning in 2018, the TCJA effectively doubled the estate, gift, and generation-skipping transfer (GST) tax exemptions for U.S. citizens. These exemptions now amount to $11.2 million for individuals and $22.4 million for married couples. The enhanced exemption will continue to increase with inflation through 2025. On Jan. 1, 2026, the exemption limits will return to 2017 amounts adjusted for inflation. Under the TCJA, the highest marginal rate for estate, gift, and GST taxes remains at 40 percent.
Understanding the estate tax is essential to any estate plan, as it could be one of the largest expenses your estate may have to pay. It is also the foundation on which many estate-planning instruments have been drafted.
The federal unified tax system
Under federal law, all property transfers are taxed under a unified gift and estate-tax system. This means that estate tax is calculated by considering your taxable estate and the adjusted taxable gifts you made during your lifetime. The result of this system is that you pay tax on the cumulative amount of wealth you transfer or give away.
Calculating estate tax
Estate tax is imposed on your taxable estate, which is the value of your gross estate, reduced by various deductions, plus certain gifts made over your lifetime less applicable credits.
Taxable property includes property owned by you (or deemed to be owned by you) at the time of your death (the gross estate). The gross estate includes all property and property interests — of any description, wherever located — at the time of your death. This includes property that passes through probate and property inherited directly by joint owners or designated beneficiaries.
Generally, your property includes the following:
• Real estate
• Personal property (example: cash, stocks and bonds, insurance proceeds, cars, furniture, jewelry, and art objects)
• Untangible property (example: copyrights, patents.)
The value assigned to each property item is typically the fair market value (FMV) on the valuation date, though other valuation methods may apply. Simply stated, FMV means the price at which property would sell for on the open market.
The following deductions are generally allowed:
• Estate expenses including funeral expenses, administration expenses (example: executor’s or administrator’s fees, court costs, attorney’s fees, and appraiser’s fees), certain debts of the decedent, certain taxes, certain claims against your estate, and casualty losses suffered during the administration of your estate.
• Unlimited marital deduction: The unlimited marital deduction lets you deduct the value of property you leave to your spouse provided he or she is a U.S. citizen from your gross estate. Although this deduction is unlimited, only certain property interests qualify, and certain conditions and requirements must be satisfied.
• Charitable deduction: The entire value of property you leave to charity is deductible from your gross estate. The gift must be to a qualifying organization and must be for a public purpose. Gifts to individuals, no matter how needy, do not qualify. Certain conditions must be met to qualify for this deduction, but the amount is not limited as it is with the income-tax deduction.
• State death-tax deduction: State inheritance or estate taxes (collectively referred to as state death taxes) paid are deductible from the gross estate.
A note about state death taxes: Many states impose their own “death taxes,” in the form of an estate tax or an inheritance tax, or both. Some states also impose a separate gift tax. Whether your estate will be subject to state death taxes depends on the size of your estate and the tax laws in effect in the state in which you are domiciled or own certain types of property.
It’s important to be aware of the differences between the federal and state gift and estate-tax laws and exemptions, which may present planning opportunities. For example, while New York State has an estate tax with a top marginal rate of 16 percent and 2018 exemption of $5.25 million, it presently does not have a gift tax.
Calculating the tentative estate tax
As noted earlier, deductions are subtracted from the gross estate, resulting in the taxable estate. If you made certain gifts during your lifetime — in excess of the annual exclusion and excluding certain qualified direct payments of tuition and medical expenses — these will also be factored into the calculation.
Deducting credits
Once your tentative estate tax has been calculated, there are credits available to apply against the tax.
• The unified credit: This credit ($5.6 million in 2018) allows you to pass an amount referred to as the basic exclusion amount (formerly known as the applicable exclusion amount) free from gift and estate tax. As of 2018, this lifetime exclusion effectively exempts $11.2 million from gift tax and estate tax. For 2011 and later years, the exclusion amount is portable; that is, any exemption that is unused by the first spouse to die may be used by the surviving spouse for gift tax and estate tax (Deceased Spouse Unused Exclusion, or DSUE). A Form 706 must be timely filed for the first-to-die spouse to claim this election.
• Credit for certain gift taxes and foreign death taxes paid
• Credit for federal estate tax on prior transfers: If your gross estate includes property that was transferred to you by will, gift, or inheritance, and on which estate tax has already been paid, you may be entitled to a credit.
Federal gift and estate exemption limits and tax
For 2018, there is an $11.2 million gift and estate tax basic exclusion amount. Any amounts exceeding the exclusion amount are taxed at the highest marginal rate of 40 percent. The 2019 rates are indexed to inflation. The IRS has not currently released the 2019 rates.
Other considerations and ways to reduce estate tax
• Utilize the annual exclusions for lifetime gifts which are currently $15,000 per recipient per year
• Invest in a 529 education savings plan and front load your contribution using a 5-year election for annual gift exclusions
• Direct payments of tuition or medical expenses. If these payments are made directly to the provider there are no gift tax consequences
• Examine your charitable-giving plan
• Review your estate-planning documents if you move to another state and after significant tax-law changes
2017 Tax Cuts and Jobs Act — Existing estate-plan documents
Since the 2017 Tax Cuts and Jobs Act essentially doubled the lifetime exemption amount — increasing it from $5.49 million in 2017, to $11.2 million in 2018 — a careful review of your estate-plan documents is important. This increase may have unintended consequences — your documents may not follow your wishes. A number of wills and revocable trusts create trusts using formula clauses tied to the exemption amount as of your date of death, which maximize the credit shelter trust.
For example, say an individual with an existing Will or Revocable Trust had a $7 million estate and intended to fund his/her credit shelter trust with the prior exemption amount of $5 million. He/she then planned to give the remaining
$2 million to other family members or a favorite charity. Under the new exemption amount, the entire $7 million would be paid to the credit shelter trust. No funds would be available for a distribution to the other family members or the charity.
Achieving peace of mind
Although reviewing your estate plan and estimating estate tax can be complicated, you can do it if you proceed step-by-step. These are important steps in understanding, formulating, and implementing a successful estate plan. The peace of mind that comes with that is worth your time.