This post will review key tax concepts that are important to understand for estate planning purposes.
Federal Estate Tax Exclusion: Generally speaking, a person's estate is subject to an estate tax. However, the amount that is excluded from federal estate tax is $5.49 million in 2017. That means a decedent's estate can be valued at $5.49 million before the highest tax rate is applied. The federal estate tax exclusion amount is inflation adjusted, so it will presumably increase every year at the rate of inflation. However, if a person's estate is above $5.49 million, the excess will be taxed at a rate of 40%.
Portability: This option allows the surviving spouse to take the deceased spouse's unused exclusion amount, if any, and add it to the surviving spouse's estate tax exclusion. Therefore, a couple can theoretically shield close to $11 million dollars in assets from estate tax. Portability used in conjunction with the unlimited martial deduction is a powerful wealth transfer tool.
Federal Gift Tax Exclusion: Generally speaking, gifts are taxable. However, as discussed before in a prior post, an individual may give up to $14,000 (in 2017) per person without paying a federal gift tax. Anything above that will require filing a gift tax return. The federal gift tax exclusion and the federal estate tax exclusion is a unified credit, so if you gift away a certain amount during your lifetime, you estate and gift tax exclusion will decrease by the amount gifted. For example, Mary gifts $1 million to her son during her lifetime. Her estate and gift tax exclusion is then reduced from $5.49 million to $4.49 million.
Unlimited marital deduction: This deduction allows spouses to pass an unlimited amount of property between themselves without paying any estate or gift taxes (if the spouse is a U.S. citizen). The unlimited marital deduction can be used to defer paying federal estate and gift taxes upon the first spouse's death.
Generation-Skipping Transfer Tax: If a person transfers assets to a "skip person", which is someone who is at least two generations below the transferor, then the federal government will impose a tax called a generation-skipping tax. The federal generation-skipping tax exclusion amount is currently $5.49 million and the federal generation-skipping tax rate is currently 40%. The federal generation-skipping tax exclusion is also unified with the federal estate and gift tax exclusion amount.
We’ve previously discussed the types of property ownership, but in this post I’d like to talk about how the value of joint property is included (or not) in a person’s estate at death.
Generally speaking, if a decedent owned property as joint tenants, the entire value of the property is included in his estate. There are a couple exceptions to this rule.
Contribution. The amount included is limited by the contribution made by the deceased joint tenant. Thus, if it can be shown that a joint tenant made a contribution to the principal of the property, then only that percentage of the property’s value will be included in the decedent’s estate. For example, if Abel and Cain each contributed $1,000 to buy some property to buy $2,000 worth of stock. The stock appreciates and is worth $5,000 at Abel’s untimely death. Only 50% of the value of that property ($2,500) will be included in Abel’s estate. This concept may be better understood with this equation:
Contribution by decedent/Total contribution by all tenants x value of joint property = Amount included in decedent’s estate
Any consideration by the surviving co-tenant does not include amounts that were originally gifted to the surviving co-tenant by the decedent. For example, Abel gave Cain $5,000 and Cain deposited it into an account and added Abel as a joint tenant. If Abel dies before Cain, the entire $5,000 would be included in Abel’s estate.
Tenancy by the Entirety (husband and wife as joint tenants): When two people are married and hold property either as joint tenants or as tenants by the entirety, exactly one-half of the value of the property is included in the decedent’s estate. The amount contributed by either spouse does not matter.
Gifting property is a valuable estate planning tool, especially for those who wish to reduce their taxable estate. In this post, we'll review some of the basics of gifting and the federal gift tax. The federal government taxes gifts to prevent people from transferring all their wealth and money tax-free before they die, thereby escaping any estate taxes.
What is a gift? A gift is any transfer of property, made directly or indirectly, from one individual to another where the individual receives nothing or less than full market value in return. Furthermore, a gift must be a "present interest", which is "an unrestricted right to the immediate use, possession, or enjoyment of property or income from property." Examples of gifts may be selling something at less than full market value or making an interest-free/reduced interest loan. Generally speaking, any gift is a taxable gift. However, there are exceptions such as:
Are gifts considered income by the donee? Generally speaking, no. The donee does not report any gifts received on his income tax return. However, any income produced by the gift after it is received by the donee is considered earned income and must be reported.
What is the annual gift tax exclusion? The annual gift tax exclusion is the amount of property a donor can transfer to an individual that will not require the donor to pay tax on the gift. In 2012, the exclusion amount is $13,000. You can apply the exclusion to each donee. For example, if you have five children, you can make separate $13,000 gifts to each of them.
What is gift splitting? For married couples, a gift made by one spouse can by considered made by both spouses equally. To split a gift, each spouse must file separate gift tax returns to show that gift-splitting was elected. For example, if the wife gave $26,000 of her own funds to her niece, the husband can elect to split the gift on his tax return so that the gift is considered to be $13,000 from the wife and $13,000 from the husband.
What is the basis of a gift? If a gift is not cash, generally speaking, the donor's holding period and basis will be assumed by the donee. Therefore, the donor should provide any and all information associated with the non-cash gift (e.g. date property was acquired, adjusted cost basis and fair market value at time of transfer) to the donee so the donee will know what taxes may be due if the property is later sold by the donee.
Does Hawaii impose a state gift tax? Simply put, nope!
What are the benefits of making gifts? First, it reduces your taxable estate. The current federal estate tax exemption is $5.12 million, but may be reduced depending on what Congress does, if anything, in the coming months. Making gifts can be a way to reduce your estate to below the exemption amount so that no estate tax will be incurred. Second, it shifts potential taxable income to an individual who may be in a lower tax bracket then yourself.
Samuel K.L. Suen is an attorney based in Honolulu, Hawaii specializing in estate planning, probate, conservatorship and guardianship matters.
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