North Reading Estate Gift & Taxes Attorney

PLANNING TO MINIMIZE LIABILITY FOR ESTATE AND GIFT TAXES AND FILING OF GIFT AND ESTATE TAX RETURNS

Attorney Roberta A. Schreiber has more than thirty years of experience working with families to establish estate plans that minimize liability for estate and gift taxes and working with Executors to ensure that estate tax returns are filled out correctly and the taxes are paid on time. A critical part of estate planning is minimizing potential liability for estate and gift taxes.

The estate tax, sometimes referred to as the "death tax", is a tax that is imposed by State and federal governments after the death of an individual, if the total value of the assets owned by the individual exceeds a certain amount. If the total value of the decedent's assets does not exceed this amount, no estate taxes are due. This tax is referred to as the estate tax because the Executor of the estate is responsible for paying it out of estate funds before distributions are made to the beneficiaries of the estate. The estate tax is due nine months from the date of death. In some cases, the Executor must sell estate assets, such as real estate or stock, to raise the money to pay estate taxes.

If you have been appointed as the Executor or Administrator of an estate, you must take this responsibility very seriously. You cannot make distributions to the beneficiaries of the estate until you have paid the estate taxes. If you distribute the estate assets before the estate taxes are paid, and you have not held back sufficient funds to pay the taxes due, you are personally responsible for paying the taxes. You can ask the beneficiaries to give back some of their distribution to pay the estate taxes, but if they refuse to do so, the money to pay the taxes comes out of your pocket.

Your Taxable Estate. The first step that the Executor must take is determining what assets are included in the taxable estate. Next, the Executor must establish the date of death value of each asset, so that he or she knows whether or not estate taxes will be due. If the decedent was married at the time of death, one-half of the couple's joint assets are included in the decedent's taxable estate. The Executor must hire a professional appraiser to establish the value of real estate, an interest in a business, corporation or partnership, and collectibles, such as antiques, coin and stamp collections, and other items with a value of $3,000 or more. For bank and investment accounts, the Executor may rely on bank and investment statements. In some cases, the Executor may use "alternate valuation" to reduce the size of the taxable estate. This planning technique is used when there is a significant drop in the value of the estate assets in the six month period following the decedent's death. This usually happens when the estate includes a large stock portfolio. If alternate valuation is chosen, the valuation date is six months from the date of death for all assets in the taxable estate. The following assets are included in the decedent's taxable estate:

• Tangible personal property, including all motor vehicles, boats, trailers, jewelry, clothing, the contents of the home and other properties, and collectibles
• All real estate, including the primary residence, a vacation home, a timeshare, rental properties, and commercial properties, held in the decedent's name alone, in joint names with one or more individuals, in a Trust, or in a partnership, LLP, LLC, or any other business entity owned by the decedent
• The funds or assets held in any type of bank, investment, or brokerage account, held in the decedent's name alone, or in joint names with one or more individuals, or in a Trust established by the decedent
• Stocks, government and corporate bonds and notes, and savings bonds held in the decedent's name alone, or in joint names with one or more individuals
• The funds or assets held in all types of retirement accounts, such as IRA's, 401-k and 403(b) plans, and profit-sharing and similar plans
• The death benefits payable under life insurance policies and annuities (the total amount paid to the beneficiaries of the policies)
• The decedent's interest in a sole proprietorship, partnership, corporation, LLC, LLP, Family Limited Partnership, or other business entity
• Assets held in most trusts in which the decedent is named as a beneficiary, except for certain types of irrevocable trusts
• Lifetime gifts in excess of the tax-exempt gift (currently $13,000 per person per year), whether or not the gifts were reported on a federal Gift Tax Return (Form 709)

The Basic Rules. When the value of all assets in the taxable estate are established, the Executor will work with an attorney or accountant to determine if an estate tax return must be filed. Following are the basic estate tax rules. Under federal estate tax laws and the laws of most States, there is an unlimited marital deduction that exempts all assets passing from one spouse to another from estate taxes, as long as the surviving spouse is a United States citizen.

For assets passing to a non-citizen spouse, the marital deduction will be applied only to those assets held in a marital "Qualified Domestic Trust", referred to as a QDOT Trust. With proper planning, no estate taxes will be due after the death of the first spouse, no matter how much the surviving spouse inherits. In addition to the marital deduction, there is an estate tax exemption. This is the amount of assets that can pass to the decedent's beneficiaries free of estate taxes, no matter what their relationship to the decedent is. The federal estate tax exemption is governed by federal laws, and each State has its own laws.

Currently, the federal estate tax exemption is $5,000,000. Some States, such as New Hampshire and Florida, have no estate or inheritance tax at this time. Other States, such as Massachusetts and Maine, have an exemption that is based on federal estate tax laws that were in effect in 2000. The Massachusetts and Maine estate tax exemption reached the maximum amount of $1,000,000 in 2006. There have been no increases since 2006 and there are no plans for future increases. The laws of the State in which the decedent resides at the time of his or her death will determine how much must be paid to that State for estate taxes. If the decedent resides in one State and owns real estate in another, his or her estate may owe estate taxes to both States. In recent years, the federal estate tax laws have changed frequently. The amount of the federal estate tax exemption is based on the date of the decedent's death, as explained below.

The federal estate tax is assessed against the entire estate, no matter where the assets are located. The tax due from the estate of a non- citizen who resides in the United States (a "resident alien") depends on a number of factors, including the terms of any tax treaties between the United States and the country in which the resident alien is a citizen. The federal estate tax is due in addition to the estate tax that may be due to the State in which the decedent resided or owned real estate. The estate of a Massachusetts resident who owns real estate in Maine may have to pay estate taxes to the Commonwealth of Massachusetts, the State of Maine, and the IRS, depending on the size of the taxable estate. The Massachusetts estate tax exemption for a Massachusetts resident who is not survived by a spouse is $1,000,000. If the taxable estate exceeds $1,000,000, the entire estate is subject to Massachusetts estate taxes, with tax rates ranging from 1% to 16%, which means that Massachusetts has a disappearing estate tax exemption.

The estate tax due from the estate of a Massachusetts resident with assets of $999,999 is zero. An estate of $1,000,001 (just two dollars more) will pay $33,200 in Massachusetts estate taxes. Massachusetts does not have a gift tax, so gifting is always a good strategy for a Massachusetts resident. I advise gifting for many of my clients who are reaching the end of their lives. As long as the gift does not exceed the current federal gift tax exemption, (currently $5,000,000), no gift taxes will be due. By gifting shortly before death, the client can reduce or eliminate liability for Massachusetts estate taxes.

The Shifting Federal Estate and Gift Tax Laws. For a decedent who died in 2009, the federal estate tax exemption was $3,500,000, and the tax rate for an estate that exceeded $3,500,000 was 45%. In 2009, an estate of $4,500,000 would owe $450,000 (45% of $1,000,000) for federal estate taxes. If the decedent was a Massachusetts resident, the Massachusetts estate tax would be $335,600. In 2009, the annual tax-exempt gift was $13,000 per person. The tax-exempt gift increases every few years, based on inflation. In 2010 and 2011, the yearly gift tax-exempt remains at $13,000 per person. Everyone may make yearly tax-exempt gifts to an unlimited number of individuals. Depending on inflation, the annual tax-exempt gift will increase to $14,000 in future years.

Example: A married couple with four children and ten grandchildren wish to reduce their taxable estate. They have yearly income of $250,000 and a taxable estate of more than $4,000,000. They live in Massachusetts, so there is no gift tax, but they will owe Massachusetts estate taxes unless they take steps to reduce the size of their estate. Each year, they may make a tax-exempt gift to each child and grandchild. Using the current tax-exempt gift of $13,000 per beneficiary per year, they may make annual tax-exempt gifts totaling $364,000 (14 x $13,000 x 2), shifting this amount out of their taxable estate to their children and grandchildren without any tax consequences or the need to file a Gift Tax Return. As long as they feel they can afford to make these gifts, they should continue the gifting program. After the death of one spouse, the surviving spouse may make annual gifts of $182,000 (14 x $13,000) to his or her children and grandchildren. If the couple does not like the idea of making outright gifts to their children or grandchildren, they may establish a trust to hold these gifts instead.

In addition to unlimited yearly tax-exempt gifts, an individual can make lifetime gifts without liability for federal gift taxes. In 2009, this amount was $1,000,000, and the gift tax rate for gifts in excess of $1,000,000 was 45%. In 2010, the gift tax exemption remained at $1,000,000, but the tax rate was reduced to 35%. Federal legislation passed in late December 2010 increased both the estate tax exemption and the gift tax exemption to $5,000,000 per person, with estates or gifts in excess of that amount taxed at the rate of 35%. These rules took effect on January 1, 2011. This legislation also changed the rules for 2010 estates, giving the Executor two choices: apply the $5,000,000 exemption to the estate and pay estate taxes on the excess or pay no estate taxes, no matter what the size of the estate. This sounds like an easy choice. Why would an Executor choose to pay estate taxes? Because the second choice (pay no estate taxes) comes with cost basis limits. Although this option applies only to 2010, it is worthwhile to review the cost basis rules that apply to all estates. Prior to 2010, all of the assets in a decedent's estate received a "stepped up" cost basis, to the date of death value. In 2010, if the Executor chooses the "no estate tax" option, the assets that receive a stepped up cost basis are limited. For assets passing to a surviving spouse, the limit is $3,000,000 and for assets passing to anyone else, the limit is $1,300,000.

Example: An individual who died in 2009 owned a waterfront vacation home that he paid $50,000 for in 1983. After he purchased it, he spent $75,000 in capital improvements. His cost basis, if he sold the home before he died, would be $125,000: the purchase price of $50,000 plus the $75,000 spent for capital improvements. If he sold the property before his death for $675,000, his capital gain would be $550,000 ($675,000 minus $125,000). If he did not sell the property before his death and his son inherited the property, the son's cost basis would be "stepped up" to the date of death value. If the house was worth $800,000 on the date of death and the son sold it for that amount, he would have no taxable capital gain. Prior to 2010, this rule applied to all assets in the estate (real estate, stock, bonds, and other investments). If this individual owned a primary residence, a vacation home, and a stock portfolio of IBM, Coca Cola, Microsoft and Apple stock purchased many years before his death, all of these assets would receive a "stepped up" cost basis to the date of death value if he died in 2009. If he died in 2010, leaving all of these assets to his son, and the total value of his estate was $7,500,000, his Executor would have to make a choice between paying estate taxes of $875,000 (35% of $2,500,000) or paying no estate taxes, but leaving the son with highly appreciated real estate and stock with a low cost basis. With the first option ($5,000,000 estate tax exemption), all assets in the estate will receive a "stepped up" costs basis to the date of death value, but $875,000 will be due for estate taxes. With the second option (unlimited estate tax exemption), no federal estate taxes will be due, but only $1,300,000 of the assets will receive a stepped up cost basis. The remaining assets, worth $6,200,000 on the date of death, will retain the father's original cost basis. As the son sells these assets, he will have to pay significant capital gains taxes on the assets that did not receive a stepped up cost basis. While the federal long term capital gains tax rate is currently 15%, it is scheduled to increase to 18% and then 20%. If the son holds onto the real estate and stock, its value could increase. The calculations to determine the best choice in this case will be complicated.

Confused by the above example? Don't worry about it. After 2010, there is no choice. The federal estate tax exemption is $5,000,000 per person, and all assets in the taxable estate receive a "stepped up" cost basis to the date of death value. There are new "portability provisions" that make it easy for husband and wife to leave up to $10,000,000 to their beneficiaries, free of estate taxes. There is still an unlimited marital deduction for all assets passing to the surviving spouse. Any assets in excess of the estate exemption will be taxed at the rate of 35%. These rules apply only to 2011 and 2012. Congress must pass legislation by the end of 2012 to continue the federal estate tax.

Planning to Minimize Estate Taxes. The good news is that you can reduce, or eliminate, liability for estate taxes with advance planning. A couple with combined assets of $2,000,000 can eliminate liability for Massachusetts estate taxes. Each spouse creates a separate taxable estate by establishing a Revocable Trust and funding each Trust with one-half of the couple's combined assets. This will allow each spouse to make use of the Massachusetts estate tax exemption of $1,000,000. Without the two Trusts, all of the couple's combined assets ($2,000,000) will be included in the taxable estate of the surviving spouse. Under laws in effect in 2011, the couple's children will have to pay Massachusetts $99,600 for estate taxes. If the couple establishes and funds two Revocable Trusts with assets of equal value, they can eliminate liability for Massachusetts estate taxes. Each spouse will have a taxable estate of $1,000,000, the amount that is exempt from Massachusetts estate taxes. Remember that this is a disappearing exemption. If the taxable estate of the surviving spouse is just $1 over the exemption, the entire estate is taxed. This type of planning is also useful in reducing liability for federal estate taxes. Establishing and funding two Revocable Trusts is a relatively simple technique that can save your family hundreds of thousands of dollars. If you do not feel comfortable gifting large amounts of money to your children and grandchildren, funding the Revocable Trusts is a far better method of reducing liability for estate taxes. You may retain control over the trust assets during your lifetime. After your death, your spouse becomes the beneficiary of both Revocable Trusts, and no estate taxes are due. After you and your spouse pass away, your children and other beneficiaries become entitled to the trust assets. The trust assets can be distributed outright to your beneficiaries, or some, or all, of the trust assets may continue to be held in trust, and invested and spent for the benefit of your children, grandchildren, and other beneficiaries. If you feel that you can afford it, you can further reduce your taxable estate by gifting, as described above. See the Trust page and the Article Titled What Type of Trust is Right for Me? For more detailed information about Trusts. Other planning options include the following:

• Establishing Marital Deduction, "Q-TIP", Credit Shelter, "Q-DOT", and Generation-Skipping Trusts
• Funding 529 Education Savings Accounts for children and grandchildren
• Making gifts to pay for medical and educational expenses (there is no limit for this type of gift)
• Charitable gifting through outright gifts, Charitable Remainder Trusts, Charitable Lead Trusts, and Charitable Foundations
• Establishing an Irrevocable Life Insurance Trust (ILIT) to exclude life insurance proceeds from your taxable estate and provide funds to pay for estate taxes
• Formation of Family Limited Partnerships, LLC's, and LLP's to allow a business owner to make "discounted" gifts of an interest in the business to family members
• Changing legal residence to another State, such as Florida or New Hampshire, to avoid the Massachusetts estate tax

For more than thirty years, Roberta A. Schreiber has worked with clients to implement estate plans that reduce, or eliminate, liability for estate and gift taxes. Roberta will help you determine the value of your taxable estate. If your estate exceeds the applicable estate tax exemptions, she will explain how taxes are calculated and make recommendations to reduce liability for estate taxes. As you can see from the above examples, you can save hundreds of thousands of dollars with a relatively simple estate plan that also avoids the need to probate your Will. After your documents have been signed, Roberta and her staff will assist you in completing the paperwork to fund your Trusts or make gifts. If it is not possible to eliminate liability for estate taxes, Roberta will make recommendations for providing the funds to pay for estate taxes, so that a vacation home or family business will not have to be sold to pay estate taxes. If you would like more detailed information about the current federal and Massachusetts gift and estate tax laws and planning techniques, please contact us to schedule an appointment.