Protect Your Estate From the Tax Man!
ESTATE AND GIFT TAX FAQ
by Mary Randolph & Denis Clifford
Will my estate have to pay taxes after I die?
It depends. The federal government imposes estate taxes at your death only if your
property is worth more than a certain amount--$600,000 to $1 million, depending on the
year of death. But there are a couple of important exceptions to the general rule. All
property left to a spouse is exempt from the tax, as long as the spouse is a U.S. citizen.
And estate taxes won't be assessed on any property you leave to a tax-exempt charity.
Important new rules also apply to family-owned
businesses and farms. Beginning in 1998, they receive a special $1.3 million exclusion
from estate tax. This amount is not in addition to the amount listed above, which is
available to everyone. For example, if when you die the general exempt amount is $700,000,
then a business that qualified for the increased exemption would get another $600,000
exemption, for a total of $1.3 million.
|2006 and after
To qualify for this special increased exemption, the business must meet several rules:
- It must be more than 50 percent of your estate.
- Its principal place of business must be in the United States.
- You must meet IRS participation requirements in the business before your death.
- You must leave your interest in the business to family members or people who have been
actively employed by the business for at least 10 years before your death. (More rules
apply if you leave th business to non-U.S. citizens.)
If the people who inherit the business stop participating in the business for at least
five of any eight-year period within the 10 years following your death, they will have to
pay back some of the tax that was avoided at your death.
Obviously, these new rules are complex and untested. Consult an estate planning
specialist if you have questions.
Don't some states also impose death taxes?
A handful of states impose death taxes. These taxes are of two types: inheritance taxes
and estate taxes.
Inheritance taxes are paid by your inheritors, not your estate. Typically, how much
they pay depends on their relationship to you. For example, Nebraska imposes a 15% tax if
you leave $25,000 to a friend, but only 1% if you leave the money to your child. But tax
rates vary from state to state. If you live in Connecticut, your child wouldn't owe any
taxes on a $25,000 inheritance, but your friend would owe 9%.
States That Impose Inheritance Taxes
State estate taxes are similar to the
estate tax imposed by the federal government. Your estate must pay this tax no matter who
your beneficiaries are. The good news is that every state except Massachusetts,
Mississippi, New York and Ohio has abolished these taxes, at least in effect. In the rest,
the state takes part of the money that you owe to the feds; it's a matter for accountants
and tax preparers, but doesn't increase the tax bill.
What are the rates for federal estate taxes?
The rates are steep, starting at 37%. The maximum is 55% for property worth over $3
Are there ways to avoid federal estate taxes?
Yes, although there are fewer ways than many people think, or hope, there are.
The most popular method is frequently used by married couples with grown children. It's
called an AB trust, though it's sometimes known as a "credit shelter trust",
"exemption trust", "marital life estate trust", or "marital
bypass trust." Spouses put their property in the trust, and then, when one spouse
dies, his or her half of the property goes to the children--with the crucial condition
that the surviving spouse gets the right to use it for life and is entitled to any income
it generates. When the second spouse dies, the property goes to the children outright.
Using this kind of trust keeps the second spouse's taxable estate half the size it would
be if the property were left entirely to the spouse, which means that estate taxes may be
Unlike a probate-avoidance revocable living trust, an AB trust controls what happens to
property for years after the first spouse's death. A couple who makes one must be sure
that the surviving spouse will be financially and emotionally comfortable receiving only
the income from the money or property placed in trust, with the children as the actual
owners of the property.
How an AB Trust Works: An Example
Ellen and Jack have been married for nearly 50 years. They have one grown son, Robert,
who is 39. Ellen and Jack create an AB trust and transfer all their major items of
property to it. They name each other as life beneficiaries, and Robert as the final
Ellen dies first. The trust automatically splits into two parts: Trust A, which is
irrevocable, contains Ellen's share of the property. Trust B is Jack's trust, and it stays
revocable as long as he is alive.
The property in Trust A legally belongs to Robert, but with one very important
condition: his father, Jack, is entitled to use the property, and collect any income it
generates, for the rest of his life. When Jack dies, the property will go to Robert free
Now let's take a look at the tax savings:
Ellen's half of the trust property is worth $500,000 when she dies.
At Ellen's death, in 1998
||$0 (because $625,000 can pass free of tax)
At Jack's death, in 2000
If Ellen had left all her property to Jack outright, his estate would have been worth
$1 million, $325,000 of which would have been taxed.
Are there other ways to save on
Yes. Common ones include what's called a "QTIP" trust, which enables a
surviving spouse to postpone estate taxes that would otherwise be due when the other
spouse dies. And there are many different types of charitable trusts, which involve making
a sizable gift to a tax-exempt charity. Some of them provide both income tax and estate
Can I avoid paying state death taxes?
If your state imposes death taxes, there probably isn't much you can do. But if you
live in two states--winter here, summer there--your inheritors may save on death taxes if
you can make your legal residence in the state with lower, or no, death taxes.
Can't I just give all my property away before I die and avoid estate taxes?
No. The government long anticipated this one. If you give away more than $10,000 per
year to any one person or non-charitable institution, you are assessed federal "gift
tax," which applies at the same rate as the estate tax. There are, however, a few
exceptions to this rule. You can give an unlimited amount of property to your spouse,
unless your spouse is not a U.S. citizen, in which case you can give away up to $100,000
per year free of gift tax. Any property given to a tax-exempt charity avoids federal gift
taxes. And money spent directly for someone's medical bills or school tuition is exempt as
But I've heard that people save on estate taxes by making gifts. How?
You can achieve substantial estate tax savings by making use of the $10,000 annual gift
tax exclusion for gifts to people and non-exempt organizations. If you give away $10,000
for four years, you've removed $40,000 from your taxable estate. And each member of a
couple has a separate $10,000 exclusion. So a couple can give $20,000 a year to a child
free of gift tax. If you have a few children, or other people you want to make gifts to
(such as your sons- or daughters-in-law), you can use this method to significantly reduce
the size of your taxable estate over a few years.
Consider a couple with combined assets worth $1 million and three children. Each year
they give each child $20,000 tax free, for a total of $60,000 per year. In seven years,
the couple has given away $420,000 and has reduced their estate to $580,000, below the
federal estate tax threshold.
Of course, there are risks with this kind of gift-giving program. The most obvious is
that you are legally transferring your wealth. Gift giving to reduce eventual estate taxes
must be carefully evaluated to see if you can comfortably afford to give away your
property during your lifetime.
From 9 Ways to Avoid Estate Taxes, by Mary Randolph & Denis Clifford.
Copyright © 1998 by Denis Clifford and Mary Randolph. Excerpted by arrangement Nolo
Press. $22.95. Available in local bookstores, or call 800-922-6656, or click here.
© 1995-2010 Reece R. Halpern. All rights reserved.