Gift and Estate Taxes - Tax Avoidance Estate Planning Strategies


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Get a better understanding of the federal gift and estate taxes and incorporate tax avoidance strategies in your estate plan.

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Gift and Estate Taxes - Tax Avoidance Estate Planning Strategies

  1. 1. Get a Better Understanding of the Federal Gift and Estate Tax and Incorporate Tax Avoidance Strategies into Your Estate Plan GIFT AND ESTATE TAXES – TAX AVOIDANCE ESTATE PLANNING STRATEGIES RICHARD B. SCHNEIDER PORTLAND OREGON ESTATE PLANNING ATTORNEY
  2. 2. If you have worked hard, saved responsibly, and invested well throughout the course of your lifetime you have likely accumulated a respectable estate that you plan to pass down to family and loved ones when you die. In order to accomplish this goal without losing a significant portion of your estate's value to federal and/or state gift and estate taxes you will need to incorporate tax avoidance strategies into your overall estate plan. WHAT YOU WANT TO AVOID In order to create an estate plan that accomplishes your tax avoidance goal you must first have a clear understanding of what you are trying to avoid. At the federal level that would be gift and estate taxes. Some states have a tax that essentially mirrors the federal tax so a discussion of the federal gift and estate tax should suffice. When you die you will leave behind an estate that is comprised of everything you owned, or had an ownership interest in, at the time of your death. As part of the probate process all of your estate assets will be identified and a date of death value ascertained for each asset. The total value of your estate is then subject to gift and estate taxes. In recent years, the gift and estate tax rate was as high as 55 percent; however, the American Taxpayer Relief Act of 2013, or ATRA, permanently established the gift and estate tax rate at a maximum Gift and Estate Taxes – Tax Avoidance Estate Planning Strategies 2
  3. 3. of 40 percent, lower than it was in recent years yet still a high enough rate that an estate could lose a significant portion of its value as a result of a gift and estate tax liability. Careful planning though can avoid this unwanted result. HOW THE LIFETIME EXEMPTION WORKS Each taxpayer is entitled to exempt from gift and estate tax the total value of gifts made during his or her lifetime or at death up to the “lifetime exemption limit”. Just as the gift and estate tax rate was subject to change, so was the lifetime exemption limit prior to the passage of ATRA. ATRA permanently established the lifetime exemption limit at $5 million, adjusted yearly for inflation. For 2013 the adjusted lifetime exemption is $5.25 million. Estate assets that exceed the lifetime exemption limit that do not qualify for another exemption or exclusion will be subject to the gift and estate tax. The easiest way for a taxpayer to understand the often confusing rules, exemptions, and exclusions that relate to gift and estate taxes is by way of illustration. Let's use Anna and John as a hypothetical married couple. Assume that John has recently died, leaving behind an estate valued at $4 Gift and Estate Taxes – Tax Avoidance Estate Planning Strategies 3
  4. 4. million. So far, John's estate would not incur gift and estate taxes because John is entitled to exempt up to $5.25 million. John, however, made gifts during his lifetime valued at $2.25 million. Because gifts made during your lifetime and at death are included, John actually has a total of $6.25 million toward his lifetime exemption limit. This leaves $1 million subject to gift and estate taxes ($6.25 million - $5.25 million = $1 million), resulting in a tax liability of $400,000. WHERE DOES THE MARITAL DEDUCTION FIT IN? The unlimited marital deduction allows a taxpayer to leave an unlimited amount of assets to his or her spouse at the time of death free from gift and estate taxes. On the surface, this sounds like the solution to John's tax problem; however, it is not that simple. John can leave his entire estate, valued at $4 million, to Anna and avoid gift and estate taxes for the moment. Because John made gifts during his lifetime valued at $2.25 million John still has $3 million of his lifetime exemption available which he will not use. Though this does solve the immediate gift and estate tax issue it may, in the long run, result in over funding Anna’s estate. For instance, assume that Anna also owns separate Gift and Estate Taxes – Tax Avoidance Estate Planning Strategies 4
  5. 5. assets valued at $4 million and then receives gifts from John when he dies valued at an additional $4 million. Anna now has an estate valued at $8 million which will then incur a gift and estate tax liability upon Anna's death. Even if Anna did not make any gifts during her lifetime she will still have an estate that exceeds her lifetime exemption limit by $2.75 million ($8 million - $5.25 million = $2.75 million). At a tax rate of 40 percent this means that Anna’s estate will lose $1.1 million to gift and estate taxes ($2.75 million x 0.40 = $1.1 million). WHAT ABOUT PORTABILITY? Clearly, losing $1.1 million to gift and estate taxes is not a desired result. The concept of "portability" can help. The concept of portability was introduced in recent years and was also made permanent by ATRA. Portability allows a surviving spouse to make use of any unused portion of the deceased spouse’s lifetime exemption limit. For John and Anna means that Anna may combine the $3 million that John did not use of his lifetime exemption limit with the $5.25 million that Anna is entitled to as her lifetime exemption for a total exemption amount of $8.25 million. Assuming that Anna's estate remains stagnant, or does not grow in the intervening years between John's death and Anna death, this means that Anna's estate will be able to avoid gift and estate taxes altogether. This is accomplished by using a total lifetime exemption of $8.25 million with a total estate value of $8 million, effectively exempting the total value of Anna's estate from gift and estate taxes. Gift and Estate Taxes – Tax Avoidance Estate Planning Strategies 5
  6. 6. USING THE ANNUAL EXCLUSION Unless Anna dies shortly after John it is unlikely that her estate value will remain stagnant. The goal of investing after all is to grow your wealth. If Anna’s estate grows by just $1 million between John’s death and her death her estate will again be threatened with gift and estate taxes. At that point Anna would have an estate valued at $9 million with just $8.25 million available in exemptions, meaning $750,000 would be subject to taxation. Anna’s estate would then owe $300,000 in gift and estate taxes ($750,000 x 0.40 = $300,000). Making use of the annual exclusion is something that Anna can do-and in fact is something that John and Anna should have been doing all along- to reduce her estate’s exposure to gift and estate taxes. The annual exclusion is a very simple and straightforward tax avoidance strategy that a taxpayer can incorporate into a comprehensive estate plan. The annual exclusion allows you to make gifts of up to $14,000 to as many beneficiaries as you wish each year. Because Anna and John are married they can make use of "gift-splitting" to double the value of each gift. Imagine that John and Anna had four children. Together John and Anna could gift assets valued at up to $28,000 to each child each year free of gift and estate taxes. Moreover, gifts made pursuant to the annual exclusion do not count toward your lifetime exemption limit. To put all of this in perspective, John and Anna could have transferred $1.12 million worth of assets tax-free and without using up any of their lifetime exemption limit over the course of just 10 Gift and Estate Taxes – Tax Avoidance Estate Planning Strategies 6
  7. 7. years ($28,000 x 4 x 10 = $1.12 million). Had they done this, Anna’s estate would not owe any gift and estate tax under the above scenario because her estate’s value would be under the $8.25 million in exemptions available. As you can see, determining your estate's potential exposure to gift and estate taxes can be complicated; however, if you have a moderate to large estate it is best to assume that your estate could incur gift and estate taxes. By doing so, you will be able to work with an estate planning attorney to create a comprehensive estate plan that includes tax avoidance as one of its primary goals. IRS, What’s New—Estate and Gift Tax Forbes, After the Fiscal Cliff Deal: Estate And Gift Tax Explained Wealth Counsel, Understanding the Impact in 2012 & 2013 of Federal Estate Tax Laws Gift and Estate Taxes – Tax Avoidance Estate Planning Strategies 7
  8. 8. About the Author Richard B. Schneider Before devoting his professional efforts primarily to estate planning, Mr. Schneider spent over fifteen years working on Wall Street for major law firms and investment banks. After graduating from law school, he practiced general civil law in New York City for five years, specializing in business transactions, financings and corporate matters. He also represented major investment banking firms in mortgage trading and real estate-related matters. Among his clients were international shipping companies, commercial and investment banks and institutional lenders, including General Electric Capital Corporation, Salomon Brothers and Merrill Lynch. For the next ten years Mr. Schneider served as Senior Vice President at the investment banking firm of Kidder, Peabody, where he managed outside legal counsel for a variety of large financial transactions between major institutions. He played a central role in the creation of Kidder, Peabody’s mortgage trading subsidiary and advised and executed transactions with insurance companies, pension funds and government agencies, including the Resolution Trust Company. In 1996 Mr. Schneider established a residence in Portland, Oregon and began his law practice there in 1997. He has made a long-term commitment to providing first-class estate planning legal services to families and individuals within the Portland metropolitan area and the surrounding SW Washington region. His motivations for moving to the Northwest were several: the natural scenic beauty of the Northwest landscape, the clean air and streets, the healthy, diversified economy and the overall high quality of life. Mr. Schneider is very grateful for the warm reception he has received from Portland/Vancouver and is pleased to have become a respected member of the Portland/Vancouver legal and business community. Mr. Schneider is a member of the American Academy of Estate Planning Attorneys, the National Academy of Elder Law Attorneys, the Estate Planning Council of Portland and is on the board of directors of the the Rental Housing Association of Greater Portland. He is admitted to practice in Oregon, Washington and New York. Law Offices of Richard B Schneider, LLC 2455 NW Marshall St, Suite 11 Portland, OR 97210 Phone: (503) 241-1215 Gift and Estate Taxes – Tax Avoidance Estate Planning Strategies 8