Creating a successful estate plan requires you to consider a number of factors and influences that will impact your plan. One of those factors is federal gift and estate taxes. All estates are potentially subject to federal gift and estate taxes at a 40 percent tax rate. Given the fact that your estate could lose almost 40 percent of its value to federal gift and estate taxes, it is imperative that you have a firm understanding of the tax and of the strategies used to reduce the impact the tax will have on your estate. If you are married you also need to understand the concept of “portability” and how it can be used to reduce any federal gift and estate tax obligation your estate may incur.
What Is the Federal Gift and Estate Tax?
The federal gift and estate tax is essentially a tax on the transfer of wealth. Both transfers made during a taxpayer’s lifetime in the form of a gift, and transfers made at the time of death in the form of an inheritance, are subject to the tax. Historically, the estate tax rate fluctuated on a yearly basis; however, with the passage of the American Taxpayer Relief Act of 2012 (ATRA) the tax rate was permanently set at 40 percent.
How Is the Tax Calculated?
An estate’s federal gift and estate tax obligation is calculated by first adding the value of all qualifying gifts made by the decedent during his/her lifetime to the value of all assets owned the decedent at the time of death (the estate’s value). For instance, if you made gifts to children and other beneficiaries during your lifetime that were worth a combined total of $2 million, and you left behind an estate worth an additional $2 million, your taxable estate value would be $4 million. If we stopped there, your estate would owe $1.6 million in federal gift and estate taxes ($4 million x 0.40 = $1.6 million).
The Lifetime Exemption
Fortunately, we do not stop there. Every taxpayer is also entitled to make use of the lifetime exemption which is essentially a deduction taken prior to calculating the tax. Historically, the lifetime exemption limit fluctuated on a regular basis prior to the passage of the American Taxpayer Relief Act of 2012 (ATRA). In 2012, ATRA set the lifetime exemption limit at $5 million, to be adjusted annually for inflation. For 2017, the exemption is $5.49 million. This means that every taxpayer may deduct $5.49 million from their taxable estate before federal gift and estate taxes are levied on the estate. For example, if your taxable estate is valued at $8 million, it will be reduced to $2.51 million after deducting the lifetime exemption for the purpose of calculating your gift and estate taxes due. In the previous example, however, the original taxable estate value was only $4 million — $1.49 million less than the lifetime exemption. What happens to the “excess” exemption amount? That is where the concept of portability becomes important.
Factoring in Portability
ATRA also made the concept of portability permanent. Portability refers to a surviving spouse’s ability to use any unused portion of a deceased spouse’s lifetime exemption. In our example, there was $1.49 million left of the lifetime exemption. The decedent’s surviving spouse would be entitled to add that $1.49 to his/her lifetime exemption amount. For 2017, that would mean the surviving spouse would have a combined lifetime exemption amount of $6.98 million ($5.49 million + $1.49 million = $6.98 million) The surviving spouse’s estate would not incur federal gift and estate taxes until the value exceeded $6.98 million as a result.
If you have additional questions or concerns related to the federal gift and estate tax and/or how portability works within the tax, contact the experienced estate planning attorneys at DeBruyckere Law Offices by calling (603) 894-4141 or (978) 969-0331 to schedule an appointment.