Estate Tax Planning

Much has been said and written about tax policy over the last couple of decades.  The public discussion has been confusing and difficult to follow, and it has proven to be impossible to predict! Congress actually worked in an unusual session over its 2012-2013 New Year Holiday to pass the “American Taxpayer Relief Act of 2012” (H.R. 8) (referred to in much of the media as the “Fiscal Cliff Deal”).

The Fiscal Cliff Deal was a mixed bag of good and bad for people of all political stripes, but it did at least add some permanency and predictability for those of us who work in estate planning.

More recently, Congress passed the Tax Cuts and Jobs Acts I December of 2017.  Although that was a broad and sweeping overall tax reform, it left transfer taxes alone for the most part (limited mainly to the doubling of the Exemption Amount).

The most important “transfer taxes” for our planning purposes are the federal gift tax, the federal estate tax, and the federal capital gains tax.

Federal Gift Tax

The Internal Revenue Code allows each individual to give other individuals or non-charitable entities up to $11,400,000 in cash or other property (in the aggregate, not per recipient) without current gift tax liability.  Each individual is also allowed to make Annual Exclusion gifts of up to $15,000 per year to any individual or non-charitable entity without reducing his or her $11,400,000 lifetime gift tax exemption. This Annual Exclusion is indexed to rise with inflation in $1,000 increments.  Since the Annual Exclusion was limited to $10,000 for many years, it is still often referred to as the "$10,000 Annual Exclusion" (or some variation thereof).  Any annual gift that exceeds the Annual Exclusion will use part of your $11,400,000 gift tax exemption.

Federal Estate Tax

The second key transfer tax is the federal estate tax.  Federal law imposes an estate tax on the value of an individual’s estate at the time of his or her death.  Transfers at death to a surviving spouse and charity are exempt from the estate tax. Thus, the federal estate tax will not apply to an individual’s estate if the total value of assets passing to beneficiaries (other than a surviving spouse or charity) does not exceed the individual’s Exemption Amount.  As of January 1, 2019, the Exemption Amount is $11,400,000 per person (up from $11,180,000 in 2018), and the tax rate on any amount over that is 40%.

Ever since the passage of the “Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010” (H.R. 4853), we have had a feature of estate tax law known as “spousal portability.” The intent of the spousal portability feature is to allow easier use of the full Exemption Amounts between spouses. In the past, couples had to do careful estate planning to make full use of their entire respective Exemption Amounts. Spousal portability allows the executor of the Deceased Spouse’s estate to transfer any unused Exemption Amount to the Surviving Spouse without such planning. In the proper circumstances, then, a married couple may transfer up to $22,800,000 in assets to heirs with much simpler planning than in the past.  It is important to note, however, that this portability is not automatic and good counsel will be required both before and after the death of the Deceased Spouse to ensure full use of both Exemption Amounts.

Federal Capital Gains Tax

The third tax to consider regarding transfers of assets is the capital gains tax.  The maximum tax on long-term capital gains sold during lifetime is 20%, although most people will fall under the 15% capital gains tax rate for at least part of their gain.  The Patient Protection and Affordable Care Act of 2010 (commonly referred to as the “ACA” or “Obamacare”) also added a surtax of 3.8% on certain investment income, including most capital gains.  The applicability of that surtax, however, depends on certain income levels and other factors.  The capital gains tax will be assessed against the gain recognized on the sale (i.e., the amount by which the net proceeds exceed the seller’s cost basis in the asset).  Under current tax law, capital assets passing to another by reason of the owner’s death receive an adjustment in the basis to the fair market value of the asset the decedent’s date of death.  Since the fair market value almost always exceeds the decedent’s cost basis, this is commonly referred to as a “stepped-up basis.”

Federal Generation-Skipping Transfer Tax

An additional transfer tax bears brief mention here—the generation-skipping transfer tax (“GSTT”).  The GSTT applies to transfers of assets that skip over one living generation to the next.  For example, a gift given to a grandchild while the parent of the grandchild is still alive will be considered a generation-skipping transfer and potentially be subject to a 40% GSTT.  Each individual may make up to $11,400,000 in such transfers during life or at death, but there is no portability allowing the Surviving Spouse to use the unused portion of the Deceased Spouse’s GSTT exemption.

Texas Estate Tax

The Texas estate tax system is commonly referred to as a “pick up’ tax.  This is because Texas picks up all or a portion of the credit for state death taxes allowed on the federal estate tax return (federal Form 706).  Since there is no longer a federal credit for state estate taxes on the federal estate tax return, there is no longer a basis for the Texas estate tax.  Texas has neither an estate tax (a tax paid by the estate) nor an inheritance tax (a tax paid by a recipient of a bequest from an estate).