Posted by: Heinz Brisske
As I am sure you are all aware, it is an election year! Every four years our television sets and radio stations broadcast campaign commercials, often pointing out the “other guy’s” imperfect political opinions. This year, the candidates’ positions on the Estate and Gift Tax are front and center. Why? Because we are facing what is known as the “Fiscal Cliff.”
Currently, at the Federal level, there is a $5.12 million estate and gift tax exemption. This exemption, also known as the applicable exclusion, is scheduled to revert back to $1 million at year’s end if Congress does not act. With the election in November, it is a guessing game as to what action, if any, will be taken to address this significant reduction in the applicable exclusion. Those with estates above $1 million have until the end of the year to utilize the current exemption of $5.12 million; it may be a situation of “use it or lose it.”
What does this mean for you?
Those with estates over $1 million should act quickly and discuss potential estate tax strategies with their estate planning professional. If no action is taken by Congress, the amount by which your estate exceeds $1 million will be subject to the Federal Estate Tax. Effectively, the current estate tax is a flat tax of 35%, but on January 1, 2013, it will go to a maximum rate of 55%.
I am married, isn’t my spouse protected by the Marital Deduction?
One of the most important and significant features of the Federal Estate Tax is that a decedent is entitled to an unlimited deduction for any amount left to a surviving spouse if certain requirements of the gift are met. Basically, those requirements mandate that the bequest to a surviving spouse be includible in the surviving spouse’s taxable estate.
Since the marital deduction is “unlimited,” it would seem to make sense for a married individual to rely completely upon the marital deduction to shelter his or her estate from estate tax upon death. This leads, however, simply to a postponement of estate tax, rather than to complete avoidance. In an ultimate sense, therefore, no tax savings have been accomplished since the unified credit available to the first spouse to die was left used.
An estate plan utilizing a “credit shelter trust” can maximize each person’s available exclusion amount and shelter more than $10,000,000 (approximately $5,000,000 in the estate of each spouse) from federal estate tax. Under current law, portability is also an option, but there are strict and burdensome requirements in order to qualify for portability, and no one knows whether portability will survive. Certainly, if Congress allows the current law to lapse, portability will lapse along with it.
Additional tax savings can be accomplished through the use of a gifting program to reduce overall estate size (see below), or by incorporating more sophisticated planning vehicles into the estate plan. Each individual should discuss these, and other, options with his or her estate planning professional.
Can I just make gifts to my children then?
It is often appropriate to make gifts during life. Gifts accomplish a number of important objectives, including the reduction of the size of an estate (and thus the estate tax consequences upon death), and the ability to participate in the beneficiary’s enjoyment of the property gifted. In 2012, each person may give up to $13,000 ($26,000 per married couple) to any number of different individuals without any gift tax consequences. There are a number of technical requirements for qualification of such gifts for the annual exclusion. If you are contemplating a gifting strategy, be sure to consult with an estate planning professional. Gifts in excess of $13,000 ($26,000 per married couple) per year per donee require the filing of gift tax returns, and will have gift and estate tax consequences.
A gift can be made directly to an individual, or it can be made to a properly drafted trust for the benefit of one or more individuals. In any event, a gift should only be made if the donor will not, under any reasonably foreseeable circumstances, have need of the property and if the cash needs of the donor are certain to be sufficient for all his or her needs.
An exception to the gifting rules described above is the direct payment of tuition and medical expenses on behalf of a child, a grandchild, or another individual. The payment of tuition directly to an educational institution on behalf of a donee or the payment of medical expenses directly to the provider of the medical treatment do not constitute taxable gifts, no matter the amount of those payments.
What about making gifts to my grandchildren?
Under current law, there is what is called a Generation Skipping Transfer Tax (GSTT). This is a tax on transfers made to or for the benefit of unrelated persons who are more than 37.5 years younger than the donor or to related persons more than one generation younger than the donor, such as grandchildren. The so-called GSTT Exemption is equal to the applicable exclusion amount, now $5.12 million.
What about Illinois? Will my estate be taxed at the state level too?
The State of Illinois, likewise, re-enacted an estate tax, decoupled from the federal estate tax, with a threshold in 2012 of $3.5 million, increasing to $4 million on January 1, 2013. The $3.5 million threshold is not an exclusion, per se, since it “disappears” for any estate of over $3.5 million. Thus, for estates below $3.5 million, there is no tax, but for estates over $3.5 million, there is a tax on the entire estate, with no exclusion from the tax.
Illinois also brought back the state QTIP election, thereby allowing decedents to plan for both the federal and state marital deduction. With proper planning, this permits a married couple to postpone taxation, regardless of estate size, of both the federal and state estate tax until the death of the last spouse to die.
The point is that there are planning options for those with substantial wealth this year that may not be available next year or in subsequent years. Whether you have enough wealth to take advantage of this year’s applicable exclusion amount or not, proper planning to reduce or avoid unnecessary taxation is your right or, some would argue, your duty. You have an obligation to your family to preserve your estate, and not to waste it. As members of society we work during our lives to shape our legacy, whether that is to provide for our family or to leave a lasting impact on the greater community. By creating an estate plan, we ensure that legacy continues beyond our death.
If you want to take advantage of the current $5.12 million exemption amount to provide the maximum amount possible to your estate beneficiaries, please call our office, at (630)682-0700 TODAY – before the year ends and the current generous estate and gift tax planning environment ends with it.