There are so many aspects to consider when analyzing how the federal estate tax affects your estate. Here are a few of the important issues.

What is the Current Law?

Unlike income taxation, the estate tax is a federal system of taxing asset transfers which take place as a result of someone’s death. While some states “piggyback” on the federal system, and charge a smaller percentage on estates subject to the tax, California currently has no estate tax.

For several years, the federal estate tax has been favorable for most Americans — from 2013 until 2017, there was no estate tax for people with less than about $5.5 million in assets. The most recent tax reform law doubled that exemption amount which is now about $11.7 million per person. For the vast majority of people, this means there will be no estate tax on the transfer of assets to heirs and beneficiaries. For much wealthier estates, the top estate tax rate is 40% on the amount above the exemption (indexed for inflation). The estate tax is due nine months after the date of death. (Caveat: This is a simplified explanation — the actual tax paid will vary due to a number of factors, including deductions and administration expenses.)

For married couples, each spouse’s exemption is portable, which means a couple can shelter double the exemption from estate tax – about $23 million can pass tax-free without complex trust provisions as needed in the past. However, the surviving spouse must file an election within nine months to take full advantage of the portability rules.

The law setting the current exemption rule will sunset in 2025.

What is the Future Law?

Although Congress may take action at any time to change the future estate tax law, if they do nothing and the current law sunsets in 2025, the exemption will revert to $5.5 million, but the rate of tax will remain the same.

What Assets are Subject to the Estate Tax?

Everything is subject to the estate tax! Your home(s), rental property, bank accounts, brokerage accounts, mutual funds, IRAs, 401(k), life insurance payments, collectibles, furniture, government savings bonds, and even your jewelry. The tax is based on the assets you have an interest in at the time of your death.

Should I Give Some Assets Away Before I Die?

Maybe — but beware the traps! One is the federal gift tax. The purpose of the gift tax is to prevent people from giving assets away solely to escape the estate tax. The safe harbor is this: You can give $15,000 per year per person (indexed for inflation) without a gift tax return. The rules beyond that are complicated, but the basic idea is that you shouldn’t shift major assets early without competent legal and tax advice. In other words, don’t try this at home!

Another trap is that you can burden your beneficiary with income tax when you give a gift too early. The reason is that the tax basis in gifted assets is equal to the giver’s basis – what the giver paid for it. If the asset is received as a bequest, the tax basis is stepped up to the fair market value on the date of death.

For example, John bought his second home for $50,000 in the 1960s and it is now worth $500,000. He wants his grown daughter to own it, so he puts it in her name (obviously without consulting with a professional advisor). Let’s say a few months later John dies. If his daughter then needs to sell the house, she will owe income tax on the full appreciated value beyond his original $50,000 basis.  If the house sells for $500,000, that means the $450,000 capital gain will be treated as income on her Form 1040. If the asset was held by her less than one year, ordinary income tax rates apply. At a 35% income tax rate, that’s $157,500 in taxes that were unnecessary! Her father should have left her the house in his estate plan instead. Then her basis would be $500,000 (date of death value) and there would be no gain subject to taxation.

What Should We Do?

For now, we are enjoying a historically generous estate tax exemption and low estate tax rates. In the first decade of this century, the estate tax exemption was down to $1 million and the tax rate was 55%, which directly affected a large number of Americans. The current estate tax system is stable enough to allow for long-term planning for households and small businesses. With an $11+ million exemption, more individuals are taking action to plan their estates without the complex documents needed to create A/B Trusts and the resulting high legal fees seen in the past.

Now is an excellent time to obtain competent legal advice to plan your estate. I highly recommend an estate check-up with your attorney to analyze how the statutory estate tax changes affect your estate.

~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~