When you think about estate planning you probably focus those thoughts on the distribution of your estate assets after your death to your loved ones. In order for there to be assets left to distribute, however, you must also make protecting your assets part of your comprehensive estate planning efforts. Some of the threats to your assets are obvious, such as creditors; however, there are other potential threats that you may not have considered. Federal gift and estate taxes, for example, could dramatically diminish the value of the estate you pass down to loved ones if you failed to plan ahead for the impact those taxes might have on your estate. For specific tax avoidance strategies that will work best in your plan, consult with your estate planning attorney. For a general overview, the attorneys at Nash Bean Ford & Brown, LLP explain some federal gift and estate tax basics.
What Are Federal Gift and Estate Taxes?
The federal gift and estate tax is essentially a tax on the transfer of wealth, imposed by Uncle Sam at a tax rate of 40 percent, that is collected after a taxpayer’s death. The tax applies to a lifetime gifts as well as all assets you own at the time of death. For example, let’s say that you made qualifying gifts during your lifetime valued at $3 million and left behind an estate valued at $5 million, the combined total of $8 million would be subject to federal gift and estate taxes. Without any further deductions or adjustments, your estate would owe Uncle Sam $3.2 million in taxes!
The Lifetime Exemption
Fortunately, every taxpayer is entitled to make use of the “lifetime exemption.” Like the tax rate, the lifetime exemption once fluctuated on a yearly basis; however, the American Taxpayer Relief Act (ATRA) of 2012 permanently set the lifetime exemption at $5 million, adjusted annually for inflation. For 2017, the lifetime exemption is set at $5.49 million. The exemption works by allowing a taxpayer to deduct the current exemption amount from the taxable estate before federal gift and estate taxes are calculated. In the above example, after deducting the lifetime exemption amount, the taxable estate is reduced to just $2.51 million. The tax bill owed to Uncle Sam the drops from $3.2 million to $1,004,000.
The Marital Deduction and Portability
No discussion about federal gift and estate taxes would be complete without mentioning two important concepts – the unlimited marital deduction and portability. As the name implies, the unlimited marital deduction allows a taxpayer to leave to a spouse an unlimited amount of assets without incurring any tax obligation. In our example, the $5 million in estate assets could be left to a spouse tax-free. Since the $3 million in lifetime gifts falls below the lifetime exemption amount, the taxpayer’s estate would avoid federal gift and estate taxes altogether; however, using the marital deduction often only delays the payment of estate taxes. If the spouse in our example also owns significant assets, leaving the $5 million in assets to him/her may over-fund his/her estate. When the surviving spouse dies, the $5 million in assets plus his/her assets will be subject to the federal gift and estate tax, meaning Uncle Sam collects in the end anyway.
Portability refers to the ability of a surviving spouse to use any unused portion of a deceased spouse’s lifetime exemption. For example, imagine that your spouse died, leaving behind an estate valued at $2 million and having made lifetime gifts of $1 million. Your spouse would only need to use $3 million of his/her lifetime exemption, leaving $2.49 million unused. That unused portion ($2.49 million) “ports” to you, the surviving spouse, and combines with your lifetime exemption upon your death, thereby increasing your total lifetime exemption amount.
At a tax rate of 40 percent, a taxpayer can lose a substantial amount of assets to the federal gift and estate tax without careful planning. To ensure that your estate assets are protected, contact the attorneys at Nash Bean Ford & Brown, LLP by calling 309-944-2188 to schedule your appointment today.