Law Offices of Will Morris

Law Offices of Will Morris


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Estate Tax Primer - A Sigh of Relief

As the “Fiscal Cliff” debate dragged on through the end of 2012, every estate planning conversation had to start with a discussion of the potential “what if’s”.  For what is now historical reference, at 12:01am on January 1, 2013 the estate tax exclusion amount was scheduled to suddenly drop for the first time in history - from $5.12M per individual and $10.24M per married couple to $1M and $2M respectively.  Simply stated, the exclusion amount is that value of an estate that is not subject to estate tax – which l refer to as the “tax free amount”.  This draconian decrease threatened to change the landscape from a reasonably comfortable safe harbor to a tax on most of the middle class.  When you start adding the value of a home, life insurance, and a 401(k) $1M because a very narrow threshold.

As the panic continued through the election, I felt that the worse possible legislative compromise would be $3.5M and $7M respectively as the President sought to roll back the tax free amount and the rates to 2009 levels.  As the discussion heated up prior to the ball dropping in NYC, it seemed to me that the estate tax would be an easy give away for the President, and so it was.  While income taxes continue to be a hot topic, the estate and gift tax issues get very little attention.

CAVEAT:  Federal estate, gift, income, and generation skipping transfer tax issues are interrelated in a complex fashion and one should consult with an estate planning or tax professional for a complete understanding.

I offer this article as a primer for conversations at cocktail parties, the coffee shop, and points in between home and the proverbial water cooler.  Here are just a few discussion topics that will give you instant credibility when visiting with your friends, golf foursomes, CPA or financial planner.

  • The estate and gift tax rules and rates are now considered permanent because they do not have a predetermined expiration date. The previous law was designed to automatically expire on December 31, 2012 and was therefore considered temporary.  “Permanent” does not mean it will never change, simply that it is not scheduled to change, making planning much less stressful. 
  • The tax free amount now has a base of $5M per person - $10M per married couple, which is indexed for inflation.  For 2013 that is estimated to be $5.25 and $10.5M respectively.  The indexing will generally provide for marginal increases each year.
  • Estates in excess of the tax free amount will be taxed at a maximum rate of 40%.
  • The estate tax free amount and gift tax free amount are now “unified” into a lifetime amount so that total tax free transfers during life or at death may total  $5M (indexed).  If a person makes a $3M gift during their life, they must file a gift tax return, but pay no tax.  At death, they can transfer $2M, but pay no tax (3+2=5). 
  • The generation skipping transfer tax (GSTT) rate is 40% for generation skipping transfers over $5M (indexed).  This is a very complicated matter in need of sophisticated planning.
  • The tax free amount is “portable” which means that any portion of the tax free amount that was not used by the first spouse to die, can be used at the death of the second spouse.  Using $5M to keep the math simple – If a husband and wife had $7M of community property at the husband’s death, his estate would have been $3.5M which is below the tax free amount.  He would have $1.5M of unused exclusion.  If at the time of the wife’s death her estate had grown to $6.5M, she could add her husband’s unused $1.5M to her $5M tax free amount and avoid an estate tax liability.  Under the old law “use or lose it” formula the wife would have paid estate tax on $1.5M. 

WARNING: To take advantage of the portability feature, an estate tax return must be filed for the husband making this election. This is a potential trap for the unwary.

 So there you have it.  When a casual conversation about estate and gift taxes arises, step right in and use the buzz words and phrases – “permanent” – “$5M indexed for inflation” – “40%” – “portable” – “GSTT is complicated” – “consult an estate planning or tax professional”. 

© Will Morris, JD, LLM 2014

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