Navigating estate tax complexities

In this article, we will begin with a “simplified,” or as simplified as possible, explanation of the estate taxes and their double first-cousin, the gift tax. Also, we need to at least mention the “generation skipping tax.”

The federal gift, estate and generation-skipping taxes are all excise taxes imposed on the transfer of property during your life or at your death. In your lifetime, the gift tax may be imposed when you make a gift transfer of money or property to anyone other than your spouse.

The generation-skipping tax is imposed by making a gift or bequest in your will or trust, made directly to a relative more than one generation removed from you, such as a grandnephew or grandchild. Be aware that this is an additional level of taxation and not a mere substitute tax.

Most gifts that you give will not be subject to gift tax because you are entitled to an annual gift tax exclusion ($12,000 in 2007) which is allowed for gifts to any one person during the calendar year. So, if an individual gave $12,000 each to seven different friends or relatives during 2006, the gifts would not be taxed and the IRS would not have to be notified that the gifts were made. But if any of the gifts were $12,001, a return would have to be filed.

In addition, gifts to a spouse or a charity are not subject to the gift tax. In future articles, we will discuss how we can use these spousal and charitable gifts to avoid or curb the effect of the estate tax.

Also excluded from the gift tax are payments of another person's educational tuition or medical expenses. Even taxable gifts can avoid gift taxation because of a tax credit that may be used to offset the gift tax.

One additional note — you and your spouse can give $24,000 to any one person. This is called gift splitting. This is a good tool to reduce the value of your estate and pass on some wealth tax free during your life. If you give more than the allowed amounts, a tax is imposed on the excess.

We can determine whether an estate tax return (for which tax might be owed) has to be filed depending upon the amount of your gross estate. Your gross estate includes the value of all property and interests you own (including the value of life insurance in your name).

The amount of your gross estate may be reduced by such items as your funeral and administrative expenses. Additionally, Congress offers a credit for estates of decedents (up to $780,800 for decedents dying in 2007) which actually shelters an “applicable exclusion amount” (up to $2 million in 2007) from estate tax.

This is called the “unified credit” because this amount is applied toward lifetime gifts as well. It will be reduced by any taxable gifts (more than $12,000) made during the decedent's lifetime.

After death, the estate tax may be assessed on the value of the property in your estate before it is distributed to your loved ones and heirs. The estate or living trust, rather than the recipient, is primarily liable for the payment of these transfer taxes. However, the recipients will be liable if the trust or estate does not pay the tax.

Up through 2009, the highest estate, generation-skipping and gift tax rates are at 45 percent. Starting in 2010, the estate and generation-skipping transfer taxes are repealed, while the top gift tax rate will be 35 percent. In other words, if you have a very large taxable estate and you die in 2010, there will be no estate tax levied.

The estate, generation-skipping, and gift tax changes under the 2001 tax legislation, however, are subject to a “sunset provision” under which the changes (including the repeal of the estate and generation-skipping taxes) shall not apply to decedents dying, gifts made, or generation-skipping transfers, after Dec. 31, 2010.

To recap a rather complicated scenario, we need to remember that there are three levels of tax relating to the giving of our property: The gift tax, the generation skipping tax and lastly the estate tax.

Remember the old maxim that “failing to plan is planning to fail.” It's true. If your estate exceeds $2 million in current dollars, you potentially have a taxable estate. You need to plan. In the next article, we will begin an exhaustive explanation of what makes up your taxable estate. Many people are surprised when they begin calculating their “assets” and determine how much they really are worth.

I want you to feel free to call, e-mail or write with any questions or comments. God bless.

EDITOR'S NOTEMark Tippins is an Auburn, Ala., attorney licensed in Alabama and Florida. For questions or comments, he can be contacted at [email protected] or (334) 821-3670.

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