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Summary of Estate Tax Laws

Kristen Hodeen Robinson, Esquire
Courtesy Law, PC

(a)    Annual Gift Exclusion.  You are permitted to give $14,000 per year to any other person (excluding your spouse because of the Unlimited Tax-Free Marital Transfers described below) tax-free without being forced to utilize any of your Personal Exemption (which is also described below).  The effect of this rule is to allow you to give $14,000 per year to each designated individual. This is referred to as the "annual gift exclusion". A husband and wife can join together in a gift of $28,000 per year per donee. This is referred to as the "split gift election".  For example, someone with 2 children, who are both married and 3 unmarried grandchildren, could give away a total of $196,000 to these 7 family members (2 children, 2 in-laws and 3 children).  Subject to certain restrictions, a gift may be made to a trust and still qualify for the annual exclusion.

(b)    Unlimited Tax-Free Marital Transfers. There is an unlimited marital deduction that permits the transfer of assets from one spouse to another, either during one's lifetime or at death, without gift or estate tax. As a result, upon the first to die of a husband and wife, there will be no estate tax to pay by virtue of the transfer of any of the assets to the surviving spouse.

(c)    Personal Exemption Amount (formerly known as the Unified Credit Equivalent). For the period January 1, 2011 through and including December 31, 2012, each individual has a $5,000,000 gift tax Personal Exemption amount and a $5,000,000 estate tax Personal Exemption amount (collectively, the “Personal Exemption”) that will shield from gift and estate tax this sum of money, whether transferred during your lifetime or at death.  In 2012, the Personal Exemption has been indexed for inflation and is actually $5,120,000.  On January 2, 2013, the Personal Exemption was permanently set at $5,000,000, to be indexed for inflation.  As such, the Personal Exemption for 2013 was the same as in 2012, or $5,250,000.  The Personal Exemption for 2014 is $5,340,000.  There is a distinct advantage to making gifts prior to death, if economically feasible, because it not only removes the $5,340,000 amount from one's estate, but also all future appreciation on that $5,340,000 asset between date of gift and date of death. The downside of such a transfer is the impact of the "carryover basis rule" (which is described later). As a result of this credit against tax, with a properly drawn will and trust for both husband and wife or by making transfers of up to $5,340,000 each during one's lifetime, up to $10,680,000 of wealth can be protected from tax.  Also, for estates of decedents dying after December 31, 2010, the executor may transfer any unused Personal Exemption to the surviving spouse.  This is referred to as "portability." 

(d)    Generation-Skipping Transfer Tax Exemption. Each person also has a $5,000,000 "generation-skipping transfer” (“GST”) tax exemption which, while not reducing estate taxes at the time of one's death, does avoid a second tax upon the death of one's child by making a gift or transfer that “skips” over a generation to a grandchild, either by outright transfer or to a trust. This exemption is also indexed for inflation and for 2014 is set at $5,340,000.  This is desirable only in fairly substantial estates and where one's children are financially set.  The generation-skipping transfer tax exemption has also since been made permanent.

(e)    Federal Tax Rates and Lifetime Gift Tax Exemption. To the extent one's estate is greater than the $5,340,000 Personal Exemption that is to be transferred to someone other than one's spouse, or $10,680,000 if a surviving spouse is taking advantage of a deceased spouse's Personal Exemption, then a federal estate tax will apply.  The current federal gift and estate tax rate is 40%.  Virginia currently has no estate tax.  Under the 2010 Tax Relief Act, the gift and estate taxes have once again become a “unified” system with the Personal Exemption Amount being the same for a gift during one’s life or a transfer at one’s death.  This unified system has since been made permanent. 
Also under the 2010 Tax Relief Act, the generation skipping transfer tax rate was been reduced to 35% for the period January 1, 2011 through December 31, 2012, but has now been increased to 40%.

(f)    Life Insurance. One asset that is often not thought of as part of one’s taxable estate are the proceeds of life insurance which are payable to a designated beneficiary. This sum is in fact included in one's estate for tax purposes if the decedent owned the policy. Planning opportunities exist in moving the ownership of a policy to a child or a trust. Life insurance also offers liquidity to an estate to pay taxes in order to avoid having to sell assets to pay estate taxes. A "second-to-die" policy is commonly used to provide this liquidity and an irrevocable life insurance trust is the most commonly used vehicle for ownership of such a policy.  By use of a properly drawn trust, the entire proceeds of the policy can be kept outside of the taxable estate, yet still available to pay estate taxes and the excess will be available for your family.  It cannot be underestimated the valuable role that life insurance can play in one’s estate planning and should be considered regardless of one’s age, health or liquidity.

(g)    Step-up in Basis. To the extent one is going to have a taxable estate, it is preferable to have the tax applied to an asset that is highly appreciated, as opposed to an asset, such as a certificate of deposit, which does not appreciate in value. The reason for this is the "step-up in basis" rule in which the appreciation in an asset (i.e. the difference between original cost and current fair market value) is not subject to income tax. As a result, an asset purchased for $100, which is now worth $1,000 and is included in one's estate, the income tax on the $900 of appreciation will never occur. The asset now has a $1,000 "stepped-up" basis in the hands of the recipient. If the recipient then sells the asset after the person's death for $1,000, they would pay no income tax whatsoever. This step-up rule even applies to assets that are transferred to the surviving spouse even though no estate tax will apply.  Qualified appraisals at death are thus very important to establish the date of death value.

(h)    Carryover Basis on Gifts. By contrast to the step-­up in the basis of assets transferred at death, any gift during one's lifetime results in a "carryover basis" to the donee. The best asset to transfer during one's lifetime is an asset whose original cost and current value is very close, but future appreciation is anticipated. Cash-like assets fit the first part of that criteria well, but not the latter. Recently acquired real estate fits both objectives, as does recently value-depressed real estate. The least desirable asset to transfer during one's lifetime is an asset which is highly appreciated already and which may be sold by the recipient within a few years after death. Generally, this type of asset would be better off being held until death and then it would receive the step-up in basis and income tax would be saved.

(i)    Three-Year Waiting Period. With certain minor exceptions, if you make a gift prior to death, the appreciation from the date of gift until death remains outside of the estate and escapes tax. However, if your gift exceeds the amount of the Personal Exemption and therefore a gift tax is required, the amount of the gift tax payment itself must be brought back into the estate to be taxed if the gift occurs within 3 years of death. This is a rule created to avoid "death-bed" gifts that one makes in order to remove from the taxable estate the amount of the tax paid on the gift.

(j)    One-Year Waiting Period. There is also a waiting period for transfers to a spouse within one year of the death of the transferor. If a spouse dies within one year of the transfer, then the step-up in basis rule will not be available as to that asset if the asset comes back to the transferor-spouse. This is also intended to stop a "death-bed" transfer of an asset from the spouse who is well to the one who is not, knowing the asset will come right back at death by the will and with the hoped for step-up in basis.

(k)    Three-Year Waiting Period for Life Insurance Policy Transfer. When there is a gift of a life insurance policy within three years of the death of the transferor, almost all of the life insurance proceeds may be brought back in to the estate of the decedent.  When an existing life insurance policy has built up some cash surrender value, it can also result in tax consequences if it is transferred due to the “transfer for value” rules.

This summary regarding the Estate Tax Laws was prepared by Courtesy Law, PC,, and is intended to provide general information about Estate Planning, Taxes, and transfers of property at death, and not specific legal advice.  For more information, consult with a competent estate planning attorney.  Ms. Robinson may be contacted at (757) 321-8217.

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