General Concepts.
Lifetime gifts and testamentary gifts are subject to both federal and state taxation. There is an exemption amount for gifting. There are no estate or gift taxes on total transfers which are less than the exemption amount.
For many years the federal exemption amount for both estate and gift taxes was $600,000 with a maximum tax rate of 55%. Recently, the estate tax exemption amount has increased to $3.5 million and the maximum estate tax rate has been lowered to 45%. Estate taxes are due within 9 months of death, and must be paid in cash.
With proper tax planning, a married couple can pass a joint estate of $7.0 million without incurring a federal estate tax. As a result, many people no longer worry about estate taxes, and there is less need to do estate tax planning.
The estate and gift taxes are scheduled to disappear in 2010, and will then return to the 2000 rules for 2011. However, it is unlikely that Congress will allow that to happen. I expect that the current estate and gift tax rules will be extended, until Congress has the time to address the question more closely.
Gift Taxes.
The federal gift tax exemption is currently set at $1.0 million. The gift tax rates on lifetime gifts over $1.0 million are graduated, starting a 41% and going up to 45%. Gift taxes must be paid by the donor at the time that the gift tax return is due.
There are two types of gifts which are excluded from gift taxes.
- a. Individuals can make gifts, during 2010, of $13,000 each to an unlimited number of persons each year. The exclusion amount increases based on inflation.
- b. There are no gift taxes on gifts for the payment of educational or medical expenses, if the gifts are paid directly to the institution. This exclusion does not apply to gifts made to individuals for their use toward such expenses.
Unlimited Marital Deduction.
There is a tremendous benefit to married couples relating to the federal estate tax. One can leave his/her spouse an unlimited amount without incurring an estate tax at the time of the first death. The estate tax on the spousal gift is deferred until the death of the surviving spouse.
If a couple have a joint estate of $3.5 million or more, proper tax planning techniques must be used to minimize the total amount of estate taxes. Both husband and wife must establish a trust on their death, which will hold the exemption amount and will protect those assets from any future estate taxes. Any assets over the exemption amount can go to the surviving spouse, either outright or in trust.
Since we can’t know who will die first, it is also important to attempt to equalize the estates of the spouses. For those with taxable estates, another approach is to make sure that the “poorer” spouse has sufficient assets to fund the exemption trust.
The failure to do the appropriate estate tax planning can be very expensive. For example, a couple who have a joint estate of $7.0 million with appropriate tax planning will pay no estate taxes. However, if the same couple owns everything as joint tenants (no tax planning), they will have an estate tax bill of over $1.5 million!
Generation Skipping Transfer Tax.
There is an additional tax on transfers which skip a generation, such as a gift from you to your grandchildren. Every generation skipping transfer is taxed at the maximum tax rate. For 2009, each person has a generation skipping exemption of $3.5 million.
Illinois Estate Taxes.
In addition to the federal taxes, the State of Illinois also imposes an estate and gift tax. For many years, the Illinois estate tax did not result in any additional taxes, because there was a reduction in the federal estate tax for the amount paid to Illinois. Unfortunately, this “state tax credit” has been phased out, and the Illinois estate tax is now separate from and in addition to the federal taxes.
The Illinois estate tax rate is graduated from xx% to yy%. To complicate things even more, the maximum exemption in Illinois is only $2.0 million (rather than the federal exemption of $3.5 million.) A couple with a joint estate in excess of $2.0 million must consider the effect of the Illinois estate tax on their estate planning.