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Estate and Gift Taxes
Whether we're discussing income, sales, capital gains, or property taxes, all of us have to deal with taxes in some form or another. After all, April 15th would not mean anything if it weren't for taxes. It doesn't matter if it's a flat tax, graduated tax, or an upside down tax... taxes are the largest expense and a major problem for us all. Taxes play a large factor in developing an effective estate plan, and eventually funding it. The largest tax bill, unfortunately, comes when you are long gone and have already become an angel... that's the day your estate taxes are due.
Estate taxes? Don't we pay enough in taxes? Yes we do. In fact, according to one Washington think tank, the average American spends more paying taxes than buying food, tobacco, clothing, and housing combined. One of our never-ending goals is to minimize taxes as much as possible, preserving wealth for yourself and loved ones. That goal does not change when it comes to effective estate planning. And with good reason. Federal estate taxes (which currently mirror gift taxes) can get much higher than your personal income tax, with rates from the IRS climbing as high as 35%. When you combine that with inheritance taxes being imposed by many states, you could see combined estate taxes climbing to 46% or higher.
When you gift over $5 million to grandchildren (effectively "skipping" a generation), the IRS slaps a double tax on you. In fact, the IRS treats such a gift as "two gifts in one" and slaps a 35% tax on the gift twice. When such a gift is hit once with a 35% tax... and then again with another 35% tax, the gift is effectively reduced by nearly 60%! That means $5 million of your hard-earned wealth immediately shrinks to just under $2,112,500 for your heirs, with the remainder going to Uncle Sam. And if you live in a state that imposes its own inheritance taxes, that amount could be even smaller.
Congress has created uniform tax rates for gifts and estate transfers of wealth (also known as the Unified Gift and Estate Tax Rates). However, since 2002, Uncle Sam has provided different tax credits to gifts and estate taxes. The Estate Tax Credit allows every American citizen to pass a certain amount of their estate to heirs tax-free. Unlike the Gift Tax Credit, a $1 million exclusion which can be used during one's lifetime (e.g. a father wishes to gift money to his daughter), the Estate Tax Credit can be used after someone has died and the estate is being distributed. With the Taxpayer Relief Act of 1997 and the Tax Relief Act of 2001, the Estate Tax Credit has gradually been increasing. But in 2010, an interesting thing happened: full repeal of both estate taxes and gift taxes. There was great uncertainty as to what would happen once 2010 ended. Lawmakers did not want estate and gifts taxes to repeal to their original 2001 levels, especially after a year where estate taxes had completely disappeared. However, on December 17, 2010, President Obama signed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. The Act provided for the federal estate tax to be restored, but not to its original 2002 levels. For tax years 2011, a special $5 million estate tax exemption was created. And for 2012, the $5 million estate tax exemption was adjusted for inflation, resulting in a total exemption of $5,120,000. Here's a breakdown
of the Estate and Gift Tax Credits and top Unified Tax Rates:
As the table demonstrates, the Gift Tax Credit historically has not been as large as the Estate Tax Credit. For gifts made in 2002 or later, the gift tax maximum exclusion was locked at $1 million. This gift tax exclusion remained in effect for subsequent years. However, the new Tax Relief Act of 2010 provides for estate and gift tax rates to be unified once again. Estate taxes are due to the IRS only 9 months from date of death. In many cases, heirs and loved ones are forced to sell personal property, real property, and other belongings at below market value to pay for this huge tax bill.
While you can never completely eliminate estate taxes, you can effectively reduce them with different types of trusts. Planning is a must. Many people with large estates, who create a simple living trust, often overlook their largest tax liability (and they won't even be around to pay it).
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