Understand how gift and estate taxes work to fully comprehend why tax avoidance strategies are commonly employed in estate planning.

1. GIFT and
ESTATE TAX
BASICS
Understand How Gift And Estate Taxes Work
to Fully Comprehend Why Tax Avoidance Strategies
Are Commonly Employed In Estate Planning
ROBERT N. NASH
ILLINOIS ESTATE PLANNING ATTORNEY

2. Although the primary goal of any estate plan is to provide a legal roadmap
for the division of estate assets at the time of death, most estate plans
attempt to achieve additional goals as well. One common goal of estate
planning is tax avoidance. To understand why tax avoidance strategies are
commonly employed in estate planning you need to understand how gift
and estate taxes work first.
WHAT IS THE GIFT AND ESTATE TAX?
The gift and estate tax is a tax that is levied on your estate at the time of
your death. All gifts made during your lifetime, as well as all assets owned
by you at the time of death, are potentially subject to gift and estate taxes.
The Internal Revenue Service, or IRS, considers anything you give away
for which you do not receive full consideration in return to be a gift. In
theory, this means that a $20 birthday gift you give a friend counts;
however, because of the lifetime exemption and/or annual exclusion
(discussed later) small gifts such as this do not actually incur gift and
estate taxes. In addition, certain types of gifts, such as gifts to a political
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3. organization or gifts designated for the payment of medical or tuition are
excluded. The value of gifts made during your lifetime added to the value
of assets owned by you at the time of your death provides the figure on
which gift and estate taxes are calculated.
Historically, the gift and estate tax
fluctuated every few years, reaching a
rate as high as 55 percent in recent years.
Recently, however, the American
Taxpayer Relief Act of 2013, or ATRA,
permanently set the gift and estate tax
rate at a maximum of 40 percent.
Although this rate is less than what it was
just a few years ago, it still means that
The gift and estate tax is a
tax that is levied on your
estate at the time of your
death. All gifts made
during your lifetime, as
well as all assets owned
by you at the time of
death, are potentially
subject to gift and estate
taxes.
you could lose a significant portion of the value of your estate to taxes
without careful planning.
THE UNLIMITED MARITAL DEDUCTION
The unlimited marital deduction
allows a taxpayer to transfer assets
of unlimited value to a spouse at the
time of death without incurring gift
and estate taxes. For illustration
purposes, imagine that Thomas and
Ellen are married at the time of
Ellen’s death on January 1st, 2014. Ellen owned assets valued at $5 million
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4. when she died and made a total of $2 million worth of qualifying gifts
during her lifetime. Ellen can leave all of the assets she owned at the time
of her death to Thomas without Ellen’s estate having to worry about gift
and estate taxes. Thomas’s estate, however, may pay the price (literally)
down the road. What many taxpayers fail to think about when using the
unlimited marital deduction is that it may overfund the surviving spouse’s
estate. Let’s assume that Thomas also owns assets valued at $5 million
when Ellen dies. Thomas now has an estate valued at $10 million which
would incur gift and estate taxes were Thomas to die tomorrow.
THE LIFETIME EXEMPTION
Each taxpayer is entitled to exempt a specific amount of gifts and assets
over the course of a lifetime from gift and estate taxes. Just as the tax rate
has fluctuated over the years, so has the lifetime exemption limit. ATRA
also took any future guess work out of the lifetime exemption limit by
setting it at $5 million, adjusted each year for inflation. For 2013, the limit
is $5.25 million, set to be raised to $5.34 million for 2014. Assuming that
Ellen left her $5 million estate to Thomas, he now has an estate valued at
$10 million. If Thomas were to die in 2014 his estate could exempt $5.34
million with the remainder being subject to gift and estate taxes. In other
words, Thomas’s estate would be taxed on $4.66 million ($10 million $5.34 million = $4.66 million). At a tax rate of 40 percent this means
Thomas’s estate would lose $1,864,000 to taxes – a significant sum for any
estate to lose.
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5. “PORTABILITY”
All hope is not lost, however, for Thomas’s estate thanks to the concept of
“portability” which was introduced in recent years and made permanent in
ATRA. Portability allows a married taxpayer to use any unused portion of
his or her spouse’s lifetime exemption. For Thomas and Ellen, portability
would allow Thomas to exempt another $3.34 million from his estate
before gift and estate taxes became due. Thomas cannot use Ellen’s entire
exemption because Ellen made lifetime gifts valued at $2 million, leaving
$3.34 of her lifetime exemption available to be “ported” over to Thomas.
By adding Ellen’s unused exemption amount to Thomas’s exemption we get
$8.68 million, Thomas’s total exemption amount. This brings Thomas’s
taxable estate down to just $1.32 million ($10 million -$8.68 million =
$1.32 million). That, in turn, brings the tax liability down from $1,864,000
to just $528,000, certainly a more favorable result but that still leaves
Thomas and Ellen’s loved ones short over half a million dollars.
THE ANNUAL EXCLUSION
With careful estate planning, Thomas and Ellen could have reduced their
exposure to gift and estate taxes
even more. While there are
numerous tax avoidance
strategies that can be
incorporated into an overall estate
plan, one of the simplest is
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6. utilizing the annual exclusion. The annual exclusion allows each taxpayer to
make gifts valued at up to $14,000 (for 2013 and thereafter) to as many
beneficiaries as the taxpayer wishes each year without incurring a gift tax.
Married couples can combine their exclusions to gift assets valued at up to
$28,000 each year. Moreover, gifts made as part of the annual exclusion
are not counted toward the lifetime exemption limit. Let’s assume that
Thomas lives another ten years after Ellen dies. Further assume that in
each of those ten years Thomas makes gifts to each of the couple’s three
children and five grandchildren valued at the yearly maximum of $14,000.
Thomas could gift $112,000 per year for a total of $1.12 million tax-free
prior to his death. Those gifts then reduce Thomas’s estate by $1.12
million as well without using any of his lifetime exemption, bringing his
taxable estate down to just $200,000 ($10 million – exemptions of $8.68
million – exclusions of $1.12 million = $200,000). Thomas’s estate now
owes just $80,000 in gift and estate taxes.
By employing gift and estate tax avoidance strategies the amount of tax
due on Thomas’s estate was reduced from $1,864,000 to $80,000, a
savings of $1,784,000 – money that will go to Thomas and Ellen’s loved
ones instead of to the IRS. Had Thomas and Ellen started earlier and
worked with an estate planning attorney there is a good likelihood that
they could have avoided a gift and estate tax obligation altogether.
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7. REFERENCES
Forbes, IRS Raises Limit on Tax-Free Lifetime Gifts
IRS, Frequently Asked Questions on Gift Taxes
Forbes, After the Fiscal Cliff Deal: Estate And Gift Tax Explained
IRS, What’s New—Estate and Gift Tax
Wealth Counsel, Understanding the Impact in 2012 & 2013 of Federal
Estate Tax Laws
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8. About the Author
Robert N. Nash
Robert N. Nash is a partner in the law firm of Nash Nash Bean & Ford, LLP. The law firm has
offices in Geneseo and Moline, Illinois and conference facilities available throughout
Northwestern Illinois. Mr. Nash chose the estate and business planning arena because he
believes it provides a positive force in his clients’ lives. He practices preventative, rather
than remedial law. Robert Nash focuses on all aspects of estate planning, including estate,
gift and income taxes, trust and probate administration, real estate, and business.
Nash Nash Bean & Ford, LLP
www.nashbeanford.com
Geneseo
Moline
445 US Highway 6 East
5030 38th Avenue, Suite 2
Geneseo, IL 61254
Moline, IL 61265
Phone: (309) 944-2188
Phone: (309)
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Fax: (309) 944-3960
Fax: (309) 944-3960
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