Estate & Gift Tax Planning

Federal and state estate and gift taxes may be imposed on whatever property you leave when you die, provided the total value of all your property is greater than a certain dollar amount.

What is the estate/gift tax “exemption”?

In 2012, the estate tax exemption — that is, the amount of property you could have before you’d start paying estate tax — is $5,120,00, with a top federal estate tax rate of 35%.  Unless Congress acts, however, the top estate tax rate in and after 2013 will be 55% (plus a 5% surtax on estates between $10 million and $17.184 million), and the tax exemption will be only $1 million.  Although you may be thinking $1 million is a lot of money, and you probably won’t pay estate taxes, you may be forgetting that all of your assets — including retirement accounts — are counted in figuring your taxable estate.

The estate and gift tax are “unified” — which means, for example, you will be able to give away a maximum of the applicable tax exemption of $1 million before paying tax, regardless whether you did so while you were alive or when you died.  If you already gave away $300,000 during your life, therefore, you will only be allowed to give an additional $700,000 at death before you start to incur estate/gift tax.

How do I reduce or eliminate payment of estate/gift tax?

While estate/gift tax planning is extremely complex and beyond a simplified or concise explanation, the gist of tax planning is to reduce the size of your taxable estate to below the applicable exemption amount.

You can do this by giving away your assets gradually while you are alive.  You are permitted every year to give away $13,000 to as many recipients as you want, without incurring any estate/gift tax on those transfers! That means this does not reduce your $1 million exemption!  This is a great way to reduce the eventual size of your estate, but it requires advance planning.

Spouses can also use so-called “AB trusts” or “QTIP trusts.”  Basically, the first spouse leaves everything in trust to the second during their lifetime (rather than leaving the property outright), with the property going to their children upon the second spouse’s death.   When properly drafted, these trusts reduce the size of the surviving spouse’s estate, creating big estate/gift tax savings.

Finally, you can use other irrevocable trusts to reduce the size of your estate. With a charitable trust, for example, you can donate property to a charity of your choice, use the income from your property during your life, and when you die, the property is not included in your taxable estate.  Similarly, you can fund a trust with life insurance.  Both types of trusts are good ways to reduce your estate so you do not incur any estate tax upon your death.

What is the generation-skipping tax (GST)?

The “generation-skipping transfer” tax (GST tax) is imposed when you give property to your grandkids.  The GST tax is the IRS’s inventive way of making sure it does not lose tax revenue.  For example, if you gave or bequeathed your property first to your children, it likely would be taxed twice before the property reached your grandkids:  once when you made the gift or bequest, and then again when your children leave the same property to your grandkids.  So if you try to “skip over” your children, the IRS would get only one chance to tax your property, not two.  So if you skip a generation and leave property directly to your grandkids, you incur a GST tax.  Fortunately, however, you still are allowed to give away $13,000 annually to your grandkids (or to anyone in fact) before you trigger the GST tax.  Those annual gifts can be made directly to the grandkids or directly to pay their tuition bills, or to an irrevocable education trust.