Board Certified, Estate Planning and Probate Law - Texas Board of Legal Specialization
Av Preeminent rated, Martindale Hubbell
Many clients would prefer planning which simply left everything to the surviving spouse outright, or to the children in equal shares outright if there were no surviving spouse. Unfortunately, transfer taxes may be very expensive. If the property to be transferred exceeds $675,000, currently, in value at the time of transfer, whether during life or at death, it is subject to transfer tax. Estate and Gift Taxes could consume as much as 55 %, plus, if Generation Skipping Transfer Tax applies, as substantial additional tax.
The U.S. transfer tax system is different from that in Japan, and different tax treatment will be apply to transfers by U.S. Citizens, transfers by Resident Aliens, and transfers by Nonresident Aliens.
This article discusses the tax treatment applicable to transfers by U.S. citizens, including those who become a naturalized U.S. citizen.
A. Transfer Tax System
Generally, the federal estate and gift tax system imposes an excise tax on gratuitous transfers, whether made during life or at death. All property owned by an individual is subject to the tax, with the tax imposed on the fair market value, not book value or income tax basis, of the property at the time of the transfer.
B. Special Note on Life Insurance
Life insurance proceeds are not subject to income tax by virtue of the definition of income found in the Internal Revenue Code They are properly includable in a decedent's gross estate and are subject to estate taxes if at the time of death the decedent owned "incidents of ownership" in the policy, i.e., had the right to say who was to receive the proceeds or how they were to be paid.
The amount includable is the full value of the policy proceeds.
C. Primary exceptions to the taxation of property properly includable in the gross estate are:
The annual gift tax exclusion, and the treatment of some items as deductible from the gross estate in determining the taxable estate against which the tax is computed.
The three most significant deductions are:
- The marital deduction
- The charitable deduction, and
- The deduction for administration expenses and debts of a decedent.
- Annual Gift Tax Exclusion
The annual gift tax exclusion is available for transfers of up to $10,000 per donor per donee per year.
If both husband and wife are both U.S. citizens or Resident Aliens and consent, one can give $20,000 and attribute half the gift to the other and have both halves treated as exempt gifts.
Excludable gifts are never taxed, thus substantial amounts of property may be transferred to beneficiaries without tax cost through appropriate use of the exclusion.
- Marital Deduction
The marital deduction may be allowed for property passing to a surviving spouse in a "qualifying manner." Essentially, if property will be included and subject to taxation in the estate of the surviving spouse, it will be eligible for the marital deduction.
An outright gift qualifies, as do certain special gifts in trust which meet the requirements of Qualified Terminable Interest Property (a "QTIP" gift).
The effect of use of the marital deduction is to defer payment of taxes until the death of the second spouse to die. If the total amount owned by the married couple exceeds $675,000 and appropriate planning is not implemented, however, (as with a "simple" all-to-spouse Will), use of the full marital deduction may actually increase the total amount of tax payable.
Note: If recipient spouse is not U.S. citizen (i.e., Resident Alien or Nonresident Alien), special rules apply, which imposes significant limitations which make tax planning essential.
- Charitable Deduction
Allowed for property passing to a qualifying charity in a "qualifying manner." Essentially, property may be given outright, or in statutoryly prescribed trust arrangements
D. How to determine the amount of federal estate and gift tax?
- Taxable Estate and Tentative Tax
Deductions are subtracted from the gross estate, and gifts during life not within the annual exclusion are added to the resulting subtotal, yielding the "taxable estate." The taxable estate is then multiplied by the applicable tax rate, which ranges from 18% to 55%, to determine the tentative federal estate and gift tax.
- Use of Unified Credit
Each individual is given a "unified credit" against the federal estate and gift tax. The amount of unified credit is the exact amount of tentative tax resulting from a taxable estate of $675,000. If a person does not use the credit either through taxable gifts during life or by disposing of property in a taxable transfer at death, it vanishes.
Thus the potential effect of a simple all-to-spouse disposition actually increase taxes if the total marital estate exceeds $675,000: gross estate, minus marital deduction, equals zero taxable estate. With no tax imposed the decedent's unified credit is gone, but the property will be includable and taxed in the survivor's estate, with only the survivor's exemption equivalent available. If a married couple does not plan apropriately, the amount of unified credit available to one spouse, will be thrown away. (one out of $675,000 X 2)
Thus, a married couple with taxable estate which exceeds $675,000 needs to think about tax planning carefully.
This tax is imposed when property is transferred in such a way that no estate or gift tax will be paid in each generation between the generation of the transferor and that of the transferee. (ex. a gift directly to a grandchild) Generation skipping transfers may be direct or in trust. In trust, such a transaction may take the form of providing benefits to child for life in a way which will not cause the property be included in the child's gross estate, with the balance left at the child's death going to grandchildren. Obviously, avoiding a 55% estate tax over several generations can be enormously beneficial. Each individual is allowed an exemption from the generation skipping transfer tax of $1,010,000 currently. Thus a married couple can shelter up to $2,020,000 from estate taxation for a number of generations to come.
If total value of your estate over $675,000? If not, don't worry about it. If it is, appropriate planning may be utilized to avoid unnecessary tax burdens.
I will discuss tax treatment applicable to those who are Resident Aliens and Nonresident Aliens in a separate article.