A closer look at the current estate and gifting tax rules
A closer look at the currentestate and gifting tax rulesInvestor EducationNew tax law brings clarity onestate taxesThe passage of the American Taxpayer Relief Act this yearmade permanent the 2012 federal estate tax and gift taxexemption levels and included an adjustment for inflation,providing clarity on those tax rates which have been fluc-tuating for several years.The estate and gift tax exemption is the dollar amount perindividual that can be sheltered from federal estate or gifttaxes. Individuals may choose to use this exemption bygifting wealth during their lifetime, leaving assets to heirsupon death, or a combination of both.The estate tax exemption was made permanent at a levelof $5 million (for individuals), indexed for inflation. For2013, with the inflation adjustment, the uniform estateand gift tax exemption was set at $5.25 million. Taxablegifts made over a lifetime will also reduce the exemp-tion amount left upon the death of an asset owner. Alsofor 2013, the annual limit for gifts to an individual wasset at $14,000. This means an individual can gift thatamount to any number of individuals without having toreport a taxable gift. Gifts larger than that amount mustbe reported, will reduce the lifetime exemption amount,and may ultimately trigger the federal tax. The maximumestate and gift tax rate was set at 40%.The law also makes a “portability provision” permanent.With portability, a surviving spouse can utilize any unusedportion of the deceased spouse’s estate tax exemption —up to the maximum individual limit — to reduce his or herown taxable estate. The spouse must choose this provi-sion upon the death of the first spouse. It is also importantto note that previously claimed exemptions are not trans-ferable if the surviving spouse remarries.Estate and gift tax rules changed frequently as taxlegislation expired, which had presented challenges forlong-range estate and legacy planning. With the now-permanent exemption levels, it is important for investorsto understand the implications of the tax thresholds andhow they may incorporate them in estate and legacyplanning.KEY ESTATE TAX FIGURES FOR 2013Estate and gift tax exemption = $5.25 million/individualMaximum tax rate = 40%Annual gifting exemption = $14,000/individualPlanning considerations undernew tax lawThe permanency of the estate tax exemption will dramati-cally reduce the number of estates that will have topay federal estate taxes for tax year 2012. For 2013, theexemption amounts are $5.25 million for individuals and$10.5 million for couples.For estates falling under the exemption amountWhile many estates will fall below the exemption level,this does not mean that only individuals and familieswith significant wealth need to focus on estate planning.The reality is that proper estate planning extends wellbeyond minimizing or preparing for federal estate taxes.Households within the exemption level should consider:•Orderly transition of wealth to heirs or charitable concernsthrough wills or other means.•Plans to address potential state estate or inheritancetaxes. There are approximately 20 states that havedifferent rules involving taxation on estates, includingexemption amounts below the federal threshold of$5 million.
•Actions to avoid a lengthy and costly probate process.Beneficiary designations on retirement accounts andinsurance contracts should be updated regularly.Establishing a revocable trust may also be useful in trans-ferring other property (such as real estate, brokerageaccounts) to heirs outside of the probate process.•Planning for minors or other extended family membersaround successor guardianship or support.•Steps to transfer decision-making responsibilities in caseof unforeseen circumstances. These steps may includeestablishing a durable power of attorney.•Living will or health-care proxy declarations, which canfacilitate decisions around medical treatment or end-of-life wishes.•Documenting wishes for final arrangements.For estates that exceed the exemption amountIn addition to the above considerations, these individualsand families should consider estate-planning strategiesto avoid or mitigate the impact of federal estate taxesincluding:•Planning for liquidity at death to pay estate taxes.Life insurance trusts, for example, may be an effectivestrategy.•Reducing the size of an estate through gifting. Here, anirrevocable trust may be useful.•Transferring wealth associated with illiquid assets, suchas shares of a closely held business, through the use ofvaluation discounts. This is often accomplished through afamily limited partnership (FLP).•Utilizing complex strategies such as a grantor retainedannuity trust (GRAT), which can transition significantwealth to beneficiaries with minimal or no use of thelifetime gift and estate exemption amount.•Charitable gift planning through trusts (CharitableRemainder or Charitable Lead Trusts) or familyfoundations.•Establishing intergenerational wealth transfer throughstrategies such as dynasty trusts.It is critical to work with a qualified estate planningprofessional to determine if any of these strategies areappropriate for your particular financial situation.Gifting considerationsThe Internal Revenue Service (IRS) defines a gift asthe transfer of property — or any type of asset — whilereceiving nothing or something less than equal valuein return. The IRS imposes a tax on gifts and limitsthe amount of assets that can be transferred betweenindividuals without being subject to the tax. Themaximum annual exclusion amount is currently $14,000per individual donor per year, or $28,000 per couple.If the gift exceeds the annual exemption, the amount isapplied to the donor’s lifetime gift limit. Ultimately,the amount applied to the lifetime limit will affect thecalculation of the donor’s estate tax.Certain transfers are not considered gifts:•Direct tuition or medical payments•Transfers between spouses•Annual transfers that do not exceed the maximumallowed ($14,000 per individual for 2013)Tax advantages of a 529 planFor those wishing to make gifts toward higher educationand contribute to a 529 savings plan, there are additionaltax advantages. A donor may make five years’ worth ofgifts at one time, for a total of $70,000. As long as thetransfers per recipient do not exceed the $14,000 annualexclusion amount (or $28,000 for spousal gifts), the totalamount is not affected by taxes.
Tax law offers clarity for planningWith several provisions of the federal estate tax andgift tax law now permanent, investors have more clarityfor estate and legacy planning. To understand howthe new rules may impact your personal financial plan,it is important to consult a financial advisor. Individualsconsidering advanced planning strategies around estatesand gifting should work with a qualified estate planningattorney who has knowledge of your particular situationand financial goals.Choosing to gift during lifetimeAssets may be transferred during an individual’s lifetime as well as upon death. The following table outlines severalconsiderations for making gifts while living.CASE FOR GIFTING WHILE LIVING CASE AGAINST GIFTING WHILE LIVING• Help heirs while you are still living.• Reduce estate assets now to avoid or minimize estatetaxes in the future.»» The gift plus its future appreciation is removed fromthe estate of the donor.• Minimize income taxes now. The gifting of income-producing assets can shift the tax burden to familymembers in lower tax brackets.• Ability to use certain valuation discounts in transferringfamily-owned businesses and farms.»» For example, gifts of closely held businesses may beeligible for significant discounts in value, up to 30%in some cases, due to the fact that these ownershipshares are not readily transferable in the open market.This is considered a “lack of marketability” discount.Also, these gifts may have limited rights attached,which would trigger a “lack of control” discount.• Certain states tax estates but not gifts. Lifetime giftsmay help minimize certain state-imposed estate taxes.• Asset protection. Gifting can shift assets to familymembers with less creditor risk.• Donors lack control over the assets after the gifthas been completed, although trusts can help donorsmaintain some level of control over gifted assets.• Loss of assets. There is the possibility that there willbe a future need for assets previously gifted to meetsignificant costs such as medical expenses, survivingspouse income needs, or helping settle future estate-related costs.• Loss of step-up in cost basis on appreciated assetsat death. With gifting, the recipient typically assumesthe original cost basis while heirs receiving assets atdeath generally assume date-of-death cost basis oninherited assets.• Potential for asset value(s) to decline after a gifthas been made.• Potential that federal estate tax may be repealedin the future.»» This scenario may be unlikely due to the needfor additional revenue to combat rising federalbudget deficits.
This information is not meant as tax or legal advice. Please consult with the appropriate tax or legal professionalregarding your particular circumstances before making any investment decisions. Putnam Retail ManagementPutnam Investments | One Post Office Square | Boston, MA 02109 | putnam.com II546 281409 5/13