HOW TO EFFECTIVELY REDUCE
FEDERAL AND STATE DEATH TAXES
Both federal and state taxes can be imposed on the transfer of property in an estate planning context. These include:
 | Federal Estate Tax on property transferred at death, if the total value transferred exceeds the exemption amount in effect in the year of death. |
| Federal Gift Tax on property gifted during life, if the total of all lifetime taxable gifts exceeds the allowable lifetime exemption. There is also an annual exclusion, currently in the amount of $13,000 per donee, for gifts of present interests in property. |
| Federal Generation-skipping transfer (GST) tax imposed on transfers from grandparents to grandchildren or more remote descendants, if the total amount of such transfers exceeds the applicable exemption amount. |
| Pennsylvania Inheritance Tax imposed both on property transferred at death (with no exemption amount) and property gifted within one year of death if the total of such gifts per donee exceeds a set exemption amount. This state tax is imposed separately from the federal estate tax. |
| Other State Estate Taxes |
If you are domiciled in another state or own realty or tangible personal property in other states, death taxes may also be due to those states.
Double Taxation on Retirement Benefits
and Other Income Tax-Deferred Assets
| Assets that consist wholly or partially of tax-deferred income are subject to two types of taxes when they pass to beneficiaries on account of death. |
Examples of such tax-deferred assets are qualified retirement accounts, annuities, and certain United State Savings Bonds.
| First, there will be federal and possibly state death taxes imposed on the date-of-death value of those assets. |
| In addition, federal income tax will be payable by the beneficiaries on the amount of tax-deferred income they receive from the inherited asset in any calendar year. |
What Property Is Subject to Death Taxes?
The definition of the "gross estate" for transfer tax purposes is much broader than the definition of the probate estate. It includes all property over which the decedent exercised ownership or control, and property the title to which the decedent may have transferred during life but still retained the use and enjoyment of it until death.
What Is the Current Law on Federal Estate Taxes?
| Rules for 2012 |
The exemption amount is $5 million for decedents dying in 2012, with the highest estate tax rate set at 35%.
However, under current law the exemption amount is due to be reduced as of January 1, 2013 to only $1 million, and the highest estate tax rate increased to 55%.
| A Long-Term Solution? |
If the federal tax legislation passed in December 2010 is any indication, we will not know until very late in 2012 what the estate tax rules will be for 2013 and beyond. Will the exemption amount stay at $5 million, or will it be reduced to $3.5 million or even as low as $1 million?
Regardless of the exemption amount chosen, will it be another temporary fix lasting only a few years, or will it finally be made permanent?
LIFETIME GIFTS AND OTHER TRANSFERS
| Death taxes are most effectively avoided by LIFETIME planning techniques. Some common lifetime techniques include: |
● Gifts made within the federal gift tax annual exclusion limit, which for 2012 is $13,000 per donee per calendar year. (The annual exclusion amount may increase in future years based on inflation.)
● Irrevocable life insurance trust to hold ownership of life insurance.
● Charitable remainder trust
◊ Allows tax-advantaged sale of highly appreciated assets
◊ Guarantees income to the grantor(s) for life or a set term of years
● Charitable lead trust
◊ Reduces the taxable value of assets ultimately intended for family members
| Valuation Discount Entities for Closely Held Business Interests - Can result in reducing the valuation of such assets for transfer tax purposes. Form of the entity can be: |
● Family Limited Partnership
● Limited Liability Company
● S Corporation
Death -Time Tax-Savings Techniques
Marital Deduction Planning
| An essential issue to consider when planning for married couples is to decide whether their assets are now (or are likely to become) large enough to suggest that they go beyond the simple "all to my spouse" type of estate plan, and engage in more sophisticated marital deduction planning. |
| Subject to the portability rules discussed blow, for married clients with combined assets in excess of the federal estate tax exemption amount, good planning should involve the utilization of the unified credit in the estate of the first spouse to die. |
This technique will entail placing assets in a special "credit shelter" trust for the surviving spouse's lifetime. The trust can benefit him or her, but will not be taxable at the surviving spouse's death.
| Planning becomes a challenge in the present climate of uncertainty over what the amount of the federal estate tax exemption will be in 2013 and beyond, and whether the concept of portability (discussed below) will remain in the law after 2012. |
| One solution is to use the "Disclaimer Trust" approach for allowing the surviving spouse's "credit shelter" trust to be created and funded after the first spouse's death. This technique affords maximum flexibility in choosing how much, if any, of the assets should be placed into trust for the surviving spouse. |
Portability of First Spouse's Unused Exemption Amount
| The Tax Reform Act of 2010 provides temporary relief for married taxpayers in the ability of both spouses’ exemption amounts to be fully utilized. The surviving spouse’s estate can now use both his or her own exemption amount, plus any exemption amount that was not used by the first spouse’s estate. |
| This "portability" rule eliminates the need for spouses to unwind jointly owned property as part of the estate planning process in an attempt to ensure that each will own assets equal to the exemption amount (since the order of deaths cannot be known). Now they can continue to own their property jointly if they wish. |
Caveat. One important caveat to this portability concept is that the surviving spouse’s estate’s use of the first spouse’s unused exemption amount will not be automatic. The executor of the first spouse’s estate must file a Federal Estate Tax Return in which the unused exemption amount is computed and an election is made allowing such amount to be used by the surviving spouse’s estate. In addition, the return must be timely filed (usually nine months after the death of the first spouse.)
Thus, planning for the use of the unused exemption amount must be done at the first spouse’s death. If not done then, it will be too late to claim the unused exemption amount at the surviving spouse’s death.
| This portability provision is due to expire at the end of 2012. However, portability may prove to be so popular a concept that it will be continued in the law regardless of what other changes may occur as of 2013. |
Charitable Remainder and Lead Trusts
| Same rules as with lifetime charitable trusts. |
