Creating a comprehensive estate plan requires taking a number of different concerns into consideration. Some of those concerns will be unique to your estate planning needs and objectives; however, one concern that everyone should consider when engaging in estate planning is the impact federal & state gift and estate taxes will have on their estate. Failing to understand the estate and gift tax could cost your estate a significant portion of its value during the probate of your estate, leaving your loved ones with considerably less than you planned to leave them. To find out exactly how gift and estate taxes will affect your specific estate is it best to consult an experienced North Dakota & Minnesota estate planning attorney; however, it also a good idea to learn some of the basics about the tax yourself.
What Is the Federal Gift Tax?
Gift and estate tax is essentially a tax on the transfer of wealth. The tax is levied on an estate at the time of the estate holder’s death to ensure that any tax obligation to the government is paid before assets are transferred to the intended beneficiaries and/or heirs of the estate. The tax applies to both the value of qualifying gifts made during the life of the decedent and the value of assets owned by the decedent at the time of death. The estate and gift tax rate was permanently set at 40 percent by the American Taxpayer Relief Act of 2012 (ATRA).
How Is the Gift and Estate Tax Calculated?
When you die, your estate will be required to go through the legal process known as “probate.” It is during that time that any gift and estate tax due must be paid. The tax is calculated by determining the value of all gifts you made during your lifetime and adding that to the value of all your estate assets owned by you at the time of your death. For example, assume that you made gifts during your lifetime totaling $3 million. Further assume that you owned assets valued at $6 million when you died. The federal gift and estate tax would apply to the total of the two, or $9 million. Without any further deductions, adjustments, or exemptions, your estate would lose a whopping $3.6 million to estate and gift taxes.
Applying the Lifetime Exemption
Fortunately, not all of your gifts and assets are actually taxed because every taxpayer is entitled to a lifetime exemption. The lifetime exemption limit was also permanently set for ATRA at $5 million; however, it is adjusted annually for inflation. For 2017, the lifetime exemption limit is $5.49 million. Therefore, you can deduct the current lifetime exemption limit from your taxable estate to arrive at the amount that is actually subject to the tax. In the example above, your $9 million taxable estate would be reduced to a $3.55 million taxable estate. Consequently, your estate’s tax obligation would also be reduced to $1.42 million. Minnesota has a lower exemption; which for 2017 is $1.8 million.
Can You Use the Marital Deduction?
People often make the mistake of relying entirely on the unlimited marital deduction as their entire estate plan without really thinking it through. The unlimited marital deduction does allow you to leave all of your estate assets (or as many as you wish) to your spouse without incurring any tax on the transfer. The problem, however, is that by transferring assets to your spouse you have potentially over-funded his or her estate. For example, if you left your remaining $3.55 million in assets to your spouse who also owns separate assets valued at $4 million. Your spouse would now face taxation on your $3.55 million and his/her $4 million ($7.55 million) upon death. In essence, relying solely on the marital deduction serves only to prolong, not eliminate, the payment of federal gift and estate taxes. Another problem with the marital deduction is that it only works if your spouse is an American citizen. Proper filings can “port” unused exemptions.
Avoiding the Gift Tax
One important benefit to working with an estate planning attorney to create your estate plan is the ability to work with the attorney to include tax avoidance strategies in your plan. For example, your attorney might suggest that you begin taking advantage of the yearly exclusion or that you transfer assets into a trust that can help with tax avoidance.
If you have additional questions about the federal estate and gift tax, contact the experienced Grand Forks estate planning attorneys at German Law Group by calling 701-738-0060 to schedule an appointment.
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