Federal Estate Tax Concepts

Federal Gift and Estate Tax

There are two fundamental concepts to understand when addressing the Federal gift and estate tax. First, any U.S. citizen can transfer, during their life or at death, an unlimited amount of assets to their spouse, if the surviving spouse is a U.S. citizen, without having to worry about Federal estate or gift tax concerns. This concept is known as the marital deduction. Essentially, the marital deduction delays the estate tax until the second death if all the assets went to the surviving widow or widower. Depending on the size of the estate, this may not be the best tax avoidance strategy.

The second concept is known as the applicable exclusion amount (or the “unified credit”). A credit is simply a dollar for dollar offset against Federal estate tax liability. There is no Federal estate or gift tax payable on an estate that is equal to, or below, the then applicable exclusion amount or credit.  (The applicable exclusion amount is a “use it or lose it” type of credit. To utilize the credit, you must (i) execute appropriate estate planning documents that allow for the use of the credit, and (ii) ensure that all assets are titled and structured in such a manner that allows for full use of the credit). Each U.S. citizen has a unified credit that is equal to the amount of estate tax payable on a taxable estate of $1.5 million in 2004 and 2005 and $2.0 million in 2006, 2007 and 2008. In essence, this is equivalent to an estate tax exemption or exclusion of this amount. This exclusion can be used during life, at death, or combined between the two, without exposure to any Federal gift or estate tax. (However, depending on your State of domicile, a State gift tax could be applicable to certain gifts).

Many estates avoid the federal estate tax because the estate tax value is less than the amount covered by available estate tax credits. The Taxpayer Relief Act of 1997 created a graduated scale which increased the estate tax credits from the year 2000 through 2006. These credits were again increased by The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), which greatly increases available credits and fully repeals federal estate tax for the year 2010. (The Sunset provisions in EGTRRA, however, will make the available credit revert to amounts mandated under the Taxpayer Relief Act of 1997, which provides for an applicable exclusion amount of $1 million after 2010, unless additional legislation is passed.)
Credits and applicable exclusion amounts are illustrated as follows:

Credits and Applicable Exclusion Amounts

Year In Which Death Occurs

The Amount Which May Be Transferred Free of Federal Estate Tax (The “Applicable Exclusion Amount”)

Highest Estate and Gift Tax Rates (Gift tax exemption remains at $1,000,000)

2001

$675,000

55%

2002

1,000,000

50%

2003

1,000,000

49%

2004

1,500,000

48%

2005

1,500,000

47%

2006

2,000,000

46%

2007

2,000,000

45%

2008

2,000,000

45%

2009

3,500,000

45%

2010

Federal estate tax and generation- skipping transfer tax fully repealed.

Gift tax is the top individual income tax rate.

2011

1,000,000 (Law reverts to law prior to the Tax Relief Act.)

55%

 

There are other deductions that may be available to family farms and certain family businesses. However, use of such deductions has been greatly limited.
Do not be fooled into thinking that tax planning is not necessary due to increasing tax credits. Basically all assets are included in the taxable estate, including the death benefit of life insurance. So if you own a home, some life insurance and are entitled to retirement plan benefits from work, your gross estate could easily exceed the threshold at which estate tax liability begins. For married couples it is important to maximize both applicable exclusion amounts (unified credit) and the marital deduction to facilitate the largest transfer of wealth among family members or desired beneficiaries.