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Estate and Gift Tax

Repeal or Suspension of the Federal Estate Tax Law 

President Donald Trump’s proposed estate and gift tax legislation would repeal the estate tax law that is commonly referred to as the “death tax.” Presently, there is a death tax (estate tax) amounting to 40% of the value of assets owned by a deceased exceeding the $5.49 million exemption equivalent.  The Trump plan states that while there would be no estate tax, capital gain assets held until death would be subject to an income tax if the estate at death has a fair market value over $10 million. The maximum capital gain tax rate would be 20% of these assets. However, it is unclear if the exemption will apply to the fair market value of the asset or only the untaxed appreciation. For the great majority of estates, those below $10 million, there will still be the same step up in basis as before and no capital gain income tax. The Trump plan will still tax gifts even if the death tax is eliminated. Without a gift tax, appreciated assets could be given to children in a lower income tax bracket and then sold by the children with the net proceeds being gifted back to the parent after the sale.

The chance of the estate tax being permanently repealed this year is unlikely unless at least 60 Senators vote in favor of this new legislation. The Republicans currently hold only 52 seats in the Senate. This would mean that 8 Democrat senators would also have to vote for a repeal of the death tax. If the repeal of the estate tax is not made permanent by a 60 or more favorable vote, the estate tax  elimination can be done through a budget reconciliation that will sunset after 10 years. This is what occurred when then President George W. Bush gradually eliminated the estate tax in 2001 only to have it return in 2011 because this 2001 law was passed in a budget reconciliation bill by a majority but without 60 favorable senate votes. A vote by a majority in a budget reconciliation to repeal the estate tax will only extend the deficit to no more than 10 years. According to the Congressional Budget Office, the repeal of the estate tax could mean the loss of close to 270 billion in revenue over the next 10 years. Thus, the repeal of the estate tax by only a majority will not be permanent due to the deficits that will be incurred as a result of this repeal.

For the time being, we will continue to report the Federal Estate and Gift Tax laws as they exist today. It will be important to keep posted on changes in this Federal Estate and Gift Tax legislation as they occur.

Federal Estate and Gift Tax Laws

There is a federal gift tax imposed on lifetime transfers of property and a federal estate tax is imposed on transfers of property at death. An exception is made when the lifetime or death transfer is made to a qualified charity. There is another transfer tax that is imposed when a substantial gift or devise is made to a person in a generation that is more than one generation younger than the person making the transfer. This is known as the generation transfer tax.

The American Taxpayer Relief Act was passed by Congress on January 2, 2013. It provided for a permanent continuation of the $5,000,000 exclusion from the estate, gift and generation-skipping tax and the continued unification for the exclusion of the estate, gift and generation-skipping tax purposes. This exemption is adjusted annually for inflation. The exclusion increased to $5,490,000 for 2017. This inflation adjustment is based on the one-year movement in the Consumer Price Index – All Urban Customers (CPI-U), as measured after August of each year. The maximum tax of 40% will apply to all gifts, devises and generation skipping transfers that are made by an individual in 2017 in excess of $5,490,000. It is important to understand that the $5,490,000 million exclusion is cumulative. Thus, a gift of $3,000,000, in 2017 will mean that only $2,490,000, is available in 2017 to gift without the payment of a federal gift tax. Likewise, a person who has made gifts during his or her lifetime of $5,490,000 will have no subsequent gift or estate tax exclusion in the year 2017, with the exception of the $14,000 annual gift tax exclusion explained below. 

Federal Estate Tax Return

If a person has at the time of death an estate that does not exceed a gross value of $5,490,000, then there is no federal estate tax and this person’s personal representative will not be required to file with the Internal Revenue Service a Federal Estate Tax return form 706. However, this return may still be filed for other reasons, such as locking in the date of death values of the decedent’s assets to establish their stepped up basis explained below or to allocate the decedent’s unused generation skipping transfer tax exemption to testamentary trusts created under the decedent’s estate plan.

If it is determined that a person does have an estate with a gross value of more than $5,490,000 then this completed Federal Estate Tax Return form 706 must be filed with the Internal Revenue Service within 9 months after the date of the decedent’s death. It is possible to file for an automatic 6 month’s extension of this deadline. However, the application for the extension must be filed before the 9 month due date.

No Florida Estate Tax

Prior to 2005, the State of Florida had a state estate tax that was a percentage of the federal estate tax but was collected by the Florida Department of Revenue. This was called the “pick up tax.” The “pick up tax” was phased out by Congress in 2005. The American Taxpayer Relief Act did not revive the pick up tax. Thus, Florida has no separate estate tax.

Determining the Gross Estate

To know whether a deceased person’s estate will be liable for federal estate taxes in 2015, the person’s gross estate first needs to be determined. A gross estate (for federal estate tax purposes) includes all property that the deceased owned or had an interest in at his or her death. The gross estate of a deceased person also includes the fair market value of property owned jointly with another except to the extent the other owner contributed toward the purchase of the property. However, for a husband and wife, there is a special 50-percent ownership rule for their jointly owned property, generally causing it to be treated as being owned equally by each spouse, regardless of who originally paid the purchase price.

The gross estate for federal estate tax purposes is comprised of the fair market value on the date of death of all stocks, bonds, tangible personal property, real property, cash, promissory notes, and the proceeds of life insurance policies owned by the deceased at death or under certain circumstances, within three years of his or her death. 

The fair market value of the gross estate is determined as of the date of the individual’s death or six months after death. The second value is known as the alternate valuation date that is allowed if the value of the gross estate is reduced and the election decreases the estate tax due the Internal Revenue Service.

Once the gross estate is determined, this amount is then reduced by funeral expenses, administration expenses, and debts and losses not reimbursed by insurance. Also, through the marital deduction, the taxable estate is reduced by whatever amount is left to the surviving spouse who is a United States citizen. The marital deduction can be taken for assets transferred to a marital deduction trust. The marital deduction trust must distribute to the surviving spouse all the net income earned on the trust assets at least annually and as much of the assets of the trust as are necessary for the surviving spouse’s health, education, maintenance, and support. In the alternative, the marital deduction trust must assure to the surviving spouse all the net income earned on the trust assets at least annually and also grant the surviving spouse a general power of appointment to state who will receive the remaining trust principal upon his or her death. The assets allocated to the marital deduction will not be subject to federal estate taxes when the first spouse dies, but may be subject to estate tax at the death of the second spouse.

Basis in Property Received From a Decedent Who Dies in 2017

Property passing from a decedent who dies during 2017 takes a “stepped-up” basis. The basis of property passing to a beneficiary from a decedent’s estate or revocable trust is the fair market value of the asset on the date of the decedent’s death. In the alternative, the personal representative (executor) of the estate of the person making the transfer at death can elect an alternate valuation date that is the earlier of six months after the decedent’s death or the date the property is sold or distributed by the estate. This step-up-in-basis generally eliminates the recognition of income on any appreciation of the property that occurred prior to the decedent’s death. If the value of property on the date of the decedent’s death is less than its adjusted basis, the property takes a “stepped-down” basis when it passes from a decedent’s estate. The reason why the stepped up or stepped-down basis is important is that a person must pay a federal income tax on the amount realized from the sale of the property less the taxpayer’s adjusted basis in this property.

Basis in Property Received During His or Her Lifetime

Basis generally represents a taxpayer’s investment in property and the cost of capital improvements made to the property less any depreciation deductions taken with respect to the property before it is sold. When a person receives a gift of property during the lifetime of the person making the gift, the donee (person receiving the property) acquires the donor’s basis. This is called the carryover basis. “Carryover basis” means that the basis in the hands of the donee is the same as it was in the hands of the donor. The basis of property transferred by lifetime gift also is increased, but not above fair market value, by any gift tax paid by the donor. The basis of a lifetime gift, however, generally cannot exceed the property’s fair market value on the date of the gift. If the basis of property is greater than the fair market value of the property on the date of the gift, then, for purposes of determining loss, the basis is the property’s fair market value on the date of the gift. The reason why the basis is important is that a person must pay a federal income tax on the amount realized from the sale of the property less the taxpayer’s adjusted basis in this property.

Portability of Unused Exemption Between Spouses

Every U.S. citizen has an exclusion against federal estate and gift taxes. This exclusion avoids the payment of a federal estate and gift tax in 2017 on assets having a value of $5,490,000. This is called the applicable exclusion amount. For U.S. citizens dying after December 31, 2010, the amount of this exclusion that remains unused at by a deceased spouse can be applied by the surviving spouse to the estate or gift tax owed on assets subsequently transferred by the surviving spouse. The unused exclusion of deceased spouse is referred to as the Deceased Spouse’s Unused Exclusion (DSUE). However, a deceased spouse’s unused exclusion amount is only available to a surviving spouse if an election to preserve this unused exclusion is made on the deceased spouse’s timely filed estate tax return, regardless of whether the estate of the predeceased spouse is otherwise required to file a federal estate tax return. This is called the portability election. It is important to remember that federal estate tax return must be filed within nine months of the date of death unless an extension is granted by the Internal Revenue Service.

It is accordingly important for a spouse to consider providing in his or her last will and testament that the Personal Representative (executor) shall make the portability election for any portion of the applicable exclusion amount that would otherwise be unused, even if it appears unclear that the surviving spouse or the surviving spouse’s estate could benefit from such exclusion. It might be argued by the heirs of the deceased spouse that the expense related to the preparation of the federal estate tax return is unnecessary. Accordingly, a spouse should consider providing in his or her last will and testament that all expenses associated with making this election shall be an expense of the deceased spouse’s administration.

It is important to remember that if the surviving spouse remarries and the new spouse predeceases the surviving spouse, the new spouse’s DSUE amount replaces the DSUE amount of the first deceased spouse, and the benefit of the DSUE of the first spouse is lost. Thus, the surviving spouse’s making gifts and using the DSUE amount as soon as possible after the death of the first spouse eliminates the possibility of losing this exclusion due to remarriage and removes all future appreciation in the assets given by the surviving spouse from his or her taxable estate. This saves estate taxes on the subsequent appreciation of these assets.

While it has always been considered best to establish a By-Pass Trust for the benefit of the surviving spouse, it is important to remember that assets transferred from the deceased spouse’s estate to a credit shelter trust for the surviving spouse will not receive a stepped-up basis adjustment upon the death of the surviving spouse. Furthermore, while the assets remain in the By-Pass Trust, any undistributed taxable income above $12,400 of taxable income will be subject to the highest income tax rates at the trust level which is 39.6%. Whereas, assets devised to a marital deduction QTIP will receive a stepped-up basis upon the death of the surviving spouse.

By example, assume the husband dies with $2.745 million in assets and the surviving spouse owns an additional 2.745 million in assets. The husband devises his 2.745 in assets to his wife. The wife timely files within 9 of the husband’s death a federal estate tax return that elects to have the husband’s unused estate tax exclusion included as his wife’s exemption exclusion.  Assume during the surviving spouse’s subsequent lifetime her assets increase in value to $8.235 million. There will be no federal estate taxes owed on the death of the second spouse if the portability election is timely made on the death of the first spouse since the surviving spouse will have a $8.235 federal estate tax exclusion amount. If the deceased spouse’s unused exclusion amount had not been claimed, there would have been and estate tax of 1,098  million estate tax because the wife’s estate will only be able to exclude $5,490 million from estate taxes (assuming  no cost of living adjustment). This is because the additional $2,745 million will have an estate tax of 40%.  

Gift Tax Annual Exclusion

Donors of lifetime gifts are allowed an annual exclusion from a gift tax in 2016 of up to $14,000 on transfers of present interests in property to each donee during a taxable year. If the non-donor spouse consents to split the gift with the donor spouse, then the annual exclusion can be up to $28,000 per donee for 2017.