When planning an estate or administering a
will or trust, what taxes may be involved?
Estate Taxes. When a person dies, their gross estate is
subject to estate taxes. For years a person could transfer $600,000 at
death without any taxation.
1998 that amount began to increase. In 2004, the amount that can pass
tax free is $1,500,000. Unless repealed or modified, the current law
increases that amount to $3,500,000 in 2009. The law is repealed, thus
an unlimited amount passes tax free, in 2010. But in 2011 the tax
threshold drops back to $1,000,000.
9/11 most estate planners anticipated that a compromise would be
reached and many believed the likely “permanent” tax free amount would
be $3,000,000. As of September 2004, with 9/11 and the budget deficits,
no one is even venturing guesses.
a person can have the following amounts in their taxable estate without
incurring any tax. For people dying in:
the tax free amount is $1,500,000
Marital Deduction. In addition to the amounts set out above, a
person may leave an unlimited amount to their spouse and incur on tax.
The gift can be outright or it can be in trust provided it meets
certain requirements including that any amount left on the death of the
survivor is subject to estate taxes at that person’s death.
Gift Tax. Since 1976, estate and gift taxes have been the
same and it has been referred to as a unified system. That has now
changed slightly. First, the maximum amount you can give this year (or
any subsequent year under the current tax laws) without incurring any
tax is $1,000,000. Even though you can die with $1,500,000 this year
and pay no tax, during your life you can only give away $1,000,000 of
it tax free under the current laws.
But note that these taxes are still cumulative. If you give away
$1,000,000 this year and then die this year, you only have an
additional $500,000 that will pass tax free.
addition to the above, every US citizen can give, tax free, to as many
people as they wish $11,000 a year. This amount was traditionally
$10,000 but has been indexed for inflation and has now grown by $1,000.
For example, a person could actually give $1,011,000 to his son this
year (assuming no prior taxable gifts) without incurring any tax.
$11,000 is per donor and per donee. Further, it can be repeated every
year. Thus, a husband and wife can give $22,000 to their son this year
tax free and without invading the $1,000,000 and then can give him
another $22,000 next year, again tax free and without invading the
illustrate how quickly this can grow; a husband and wife with 3
children and 2 grand children can give $132,000 (2 [husband and wife] x
3 [3 children] x 2 [2 grandchildren] x $11,000) a year to their
descendants. Thus over a 3 year period they can transfer, tax free,
almost $400,000 and still have the $1,000,000 available.
$11,000 person donor, per donee, per year, amount is sometimes referred
to as a present interest exclusion. For a gift to be treated as
nontaxable, it must be presently available to the beneficiary. $11,000
in cash handed to a child qualifies. However, if that $11,000 is put
into trust and the child is not to receive these funds for 1 year, then
it does not qualify.
common device, and one used extensively in life insurance trusts, is to
give the child a right to withdraw the funds for a limited period of
time. This right, frequently referred to a Crummy right of withdrawal,
makes the gift a present interest and qualifies as a present interest
Generation Skipping Tax. Generation skipping occurs if a
person leaves their property in a form that avoids that property being
subject to estate taxation on the death of a beneficiary. For example,
if I leave my estate to a trust that will continue until the death of
my child, the trust would not be subject to the estate tax on my
child's death. This is true even if my child is the trustee and the
Exemption. However, there is an exemption amount. As of 2004,
the exemption is now tied to the estate tax exclusion amount. So for
2004 the amount that can pass into a GST arrangement without a GST tax
is $1,500,000. This amount will rise through 2010 as described above
and then fall back to $1,000,000 in 2011.
Inheritance Tax (State of Texas). The State of Texas has a
death tax; however, it is a sponge or pick up tax and has little impact
on planning or administration. However, it may change in the near
future. Traditionally this tax required no consideration because it was
equal to a federal credit for state death taxes paid. Thus it was
merely money that would have otherwise been paid to IRS.
federal estate tax credit is now being phased out and represents a loss
of about $300,000,000 to the State of Texas each year. There are no
current plans to change this tax to avoid these lost revenues, but if
the Texas budget continues to be tight, politicians may turn to this
Income Tax. The income tax has a widespread effect on planning
and administration. The following are just a few of the basic issues.
Rule. All income is subject to tax all the time. While a
person is living, that person reports his income and pays tax on it.
When a person dies, his estate reports all of the income from the date
of death until the estate is closed. If there are distributions to
beneficiaries, they will report the income and pay tax. If there are no
distributions to beneficiaries, then the trust or estate will pay the
tax. Except to the extent a distribution is deemed a distribution of
income, property distributed to the beneficiary is not counted as
income. But, when the property is distributed, the beneficiary begins
paying income tax on the income the property generates from the date it
is turned over to the beneficiary.
Insurance. The proceeds from a life insurance policy are not
subject to income tax. However, this should not be confused with the
estate tax. Life insurance, unless properly handled, is subject to the
estate and gift tax and may be a part of the decedent's gross estate.
Gains: Basis. When you sell an asset, you pay tax on the
difference between your basis and the net sales price. Basis is
generally the purchase price less any prior claimed depreciation. When
an asset is given to you, you take your donor's basis. On the other
hand, if you inherit an asset, you get a step up in basis to date of
death value. For example: Dad gives Exxon stock to his son; it is worth
$8,000 on the date of gift but dad only paid $2,000 several years ago.
Son sells the stock for $8,000. The gain (and reportable income) is
$6,000. On the other hand if Dad leaves his Exxon stock to his son and
on the date of dad's death the stock is worth $8,000. If son
subsequently sells it for $8,000, son has a gain of 0 and a tax of 0 .
Gains: Community Property. This step up in basis at death
applies not only to the decedent’s property but also the surviving
spouse’s community ½ as well. So, if a man dies owning with his
wife as community property the Exxon stock referred to above. If wife
is left the stock and then sells it her basis is $8,000 not $5,000)
($4,000 plus $1,000).
Compensation. There is no step up in basis for deferred
compensation. If dad has an IRA worth $100,000 and he names his
daughter as the beneficiary, the IRA is not only subject to the estate
tax but also the income tax. The IRA is a part of the gross estate.
Also, income tax must be paid on the IRA.
spouse can roll an IRA over and treat it as if it was originally hers.
A beneficiary can elect to draw an IRA over his or her life expectancy.
You should avoid naming an estate as the beneficiary of an IRA, that
will probably result in the IRA being fully taxed almost immediately.
Finally, a trust should be named as the beneficiary only with the
greatest of caution and professional input.