Donald L. Field, Jr.
Attorney at Law
601 Montgomery Street, Suite 1088
San Francisco, California 94111
Offering planning, implementation, advice and representation of taxpayers before federal and California courts and Agencies regarding income, franchise, sales, real property, estate and gift taxes since 1979
The U.S. estate tax is generally imposed upon the value of all property comprising a decedent's (deceased person's) estate. As further described below, there are exclusions available where the surviving spouse is a US citizen and to others based on an exclusion amount which is $5.49 million. There is also a provision which allows a surviving spouse in some cases to used any exclusion amount which was not used on first death ("portability"). The maximum estate tax rate on the taxable estate is 40%.
Availability of the Marital Deduction
A very significant deduction and planning tool normally available to estates is the so-called unlimited marital deduction. The unlimited marital deduction allows the estate a deduction equal to the value of all property passing to a surviving spouse. Therefore, if all estate assets pass to a surviving spouse no estate tax is due (although the assets may be subject to estate tax upon the later death of the surviving spouse). However, the estate of a decedent is entitled to the unlimited marital deduction only if the surviving spouse is a U.S. citizen.
If the surviving spouse is not a U.S. citizen, transfers qualify for the marital deduction only in two limited circumstances: (1) the surviving spouse becomes a U.S. citizen before the U.S. estate tax return is filed, and was domiciled in the U.S. between the date of the decedent's death and the surviving spouse's naturalization; or (2) the property passes to a qualified domestic trust (QDOT) or similar contractual arrangement for the benefit of the surviving spouse.
The QDOT serves to defer the decedent's estate tax due until a later triggering event. The actual taxation of the QDOT occurs at estate tax rates otherwise available to the decedent, thereby allowing the decedent's estate to take advantage of the lower marginal rates. Triggering events resulting in taxation include the death of the surviving spouse, the termination of the trust as a QDOT, or any distribution of principal from the QDOT during the surviving spouse's life, except mandatory distributions required to qualify as a QDOT and distributions of trust principal on account of hardship.
Availability of the Lifetime Exclusion
Under current U.S. law citizens and residents are also entitled to an exclusion from estate taxes of $5,490,000. This affects any amounts which are given to a nonspouse (children, grandchildren or others) at an individual's death. The new law passed in late 2012 also permits a surviving spouse to use the exemption of amount of the first spouse to die, if it was not fully applied at first death. See also our page on federal estate taxes
Portability does not, howver, address asset appreciation. With traditional estate planning, the amount exempted from federal estate taxes for the first-to-die spouse is put into a trust for the benefit of the surviving spouse. The assets in this trust, no matter their amount, are outside of the estate of the surviving spouse for estate tax purposes. This means that this trust can appreciate in value to any size, and will not be subject to federal estate taxes when the surviving spouse dies. With portability, however, when one spouse dies and transfers assets and any unused portion of the federal estate tax exclusion to the surviving spouse, any appreciation on the assets of the deceased spouse will be included in the estate of the surviving spouse. If the surviving spouse’s estate (including the deceased spouse’s assets and appreciation on those assets) is larger than the surviving spouse’s available federal estate tax exclusions (including any unused federal estate tax exclusion transferred from the deceased spouse), federal estate tax will be owed on the difference.
If you believe your total marital assets are above, or have the potential of appreciating above, the federal estate tax applicable exclusion amount, you may want to consider working with an estate planning professional to create a traditional estate plan. By doing so, you can help ensure that any potential appreciation of the first-to-die spouse’s assets accumulates outside the estate of the surviving spouse.
Furthermore, portability does not apply to the generation-skipping transfer (GST) tax exemption. In 2013, individuals can exclude up to $5,490,000 worth of transfers from the GST tax. Unlike the federal estate tax exclusion, however, the GST tax exemption is not portable, as any unused portion does not transfer to a surviving spouse. You should consult your estate planning attorney to determine whether you should make a GST in the future. If so, ask how to effectively utilize all available GST tax exemptions.
Under federal tax law an individual can give up to $14,000 per year to an unlimited number of other individuals without incurring gift tax. In the case of a husband and wife, a total of $28,000 can be given each year, regardless of whether the source of the gift is community property, joint tenancy property or separate property. An individual can in addition at any time during his or her lifetime give up to $5,490,000 to individuals other than a spouse without incurring federal gift tax. All gifts to a US citizen spouse are taxfree(foreign spouses have a limit of $149,000). There is also an exclusion for gifts of medical expenses and educational expenses (paid directly to the institution) in some cases. If the annual exclusion is exceeded in any year, a gift tax return is required, even if no tax is due.
Increase in Income Tax Basis
Transfers at death (but not lifetime gifts) result in an increase in the basis for computation of capital gain for the asset transferred to the fair market value at the date of death (or an optional alternate valuation date. This means that careful consideration should be given to the selection of assets which are transferred intervivos (lifetime gifts) and those transferred at death (whether by will or by trust).