By Rafael Ruano
Planning for your estate starts with knowing the basics.
As an estate planning attorney, discussions about estate taxes, or "the death tax," usually require me to spend time explaining the tax system and defining terms.
Since President Barack Obama signed the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act in December 2010, the system has—temporarily—changed, and a few new terms have been added to the lingo.
The following is a glossary of the basic estate tax terms needed to understand this often confusing and fluid issue.
Importantly, the new federal estate tax law makes significant changes, but only for 2011 and 2012.
In 2013, the law reverts back to what it was in 2001—unless Congress acts and either extends the new set of laws or changes them yet again (see page 34 for details). While we have a set of rules, the likelihood of the rules staying the same for any length of time depends on the political and eco-nomic factors that will play into how Congress acts or fails to act before 2013.
Rafael Ruano is an estate planning attorney with Goyette & Associates in Gold River, Calif. Contact him at firstname.lastname@example.org or (888) 993-1600.
The sum of all assets and debts held (owned) by an individual during his or her life or at the time of his or her death.
Estate Tax Exemption
For 2011 and 2012, the federal estate tax exemption is $5 million, and the estate tax rate for estates valued at more than this amount is 35%. This means that an individual can transfer up to
$5 million without incurring any federal estate taxes. A married couple can thus pass $10 million without incurring estate taxes (see "Portability"). Like the estate tax exemption, the gift tax exemption and generation skipping transfer tax exemption are $5 million each, and the tax rate for both of these taxes is also 35% (see "Generation-Skipping Tax" and "Gift Tax").
Tax that is assessed on property that is passed to a generation that is two or more levels below the generation of the person who is making the transfer. For example, a transfer of property from a grandparent to a grandchild while the child of the grandparent is alive would be subject to the generation-skipping transfer tax. The $5 million federal estate tax exemption applies.
Tax assessed on the value of property that is gifted from one person to another. The person who makes the gift is the one responsible for paying the gift tax and reporting the gift to the Internal Revenue Service on Form 709, while the person who receives the gift does not need to report the gift as part of his or her income. In 2011, federal law exempts the first $13,000 of gifted property to each individual from the federal gift tax. Individuals can make gifts of up to $13,000 to as many people as they want, with a married couple able to make a total gift of $26,000 to one individual without incurring gift taxes. The $5 million federal estate tax exemption applies.
For 2011 and 2012, if the first spouse dies and didn’t use up all of his or her federal exemption from estate taxes, the exemption that was not used is transferred to the surviving spouse’s exemption. The surviving spouse can then use the deceased spouse’s unused exemption plus his or her own exemption when he or she later dies. This portability used to be available only through the use of a revocable A-B trust, but it has now been made available to those who die in 2011 and 2012. Since this new aspect of federal estate tax law has been enacted only for this year and next, it is risky to solely rely on this new rule for federal estate tax planning.
The court-supervised process of transferring assets from one generation to the next. The court establishes the authenticity of the will (if any), appoints a personal representative or administrator, identifies heirs and creditors, directs payment of debts and taxes and oversees distribution of the assets according to the will or state law in the absence of a will. Assets in a revocable trust or jointly owned by the decedent (the individual who passed away) and another person do not have to go through probate to be distributed. In some jurisdictions (such as California), the probate process can take six to nine months at a minimum, and be costly (fees as high as 5% of the market value of the estate)—and that assumes that there are no family feuds. The probate process, even more so than estate taxes because they affect only relatively large estates, is the No. 1 reason that revocable trusts are so common in the U.S. today.
State Estate Taxes
Many states also impose their own estate taxes. Some states mirror the federal estate tax law such that if the estate is exempt from federal taxation it is also exempt from state taxation. However, some states have their own independent estate tax law, so it is possible for an estate to be subject to state tax while exempt from federal tax.
The original or acquisition value of a property is used to determine the amount of tax that will be assessed. The basis is deducted from the sales price of the property when it is sold to determine the profit or loss. For 2011 and 2012, the federal estate tax makes use of the "unlimited step-up basis," which allows for a beneficiary or heir to take property at a basis value of the current value of the asset, as opposed to the value of the asset when it was acquired by the decedent.