10. Estate and Gift Tax – Part 1

This is part 10 in my series, Estate Planning – What You Need to Know.

Part 10. Estate and Gift Tax – Part 1

The estate tax, aka the death tax, and the gift tax are separate but related. Let’s start with the estate tax.

Estate Tax

The estate tax is the tax the federal and state government levies on your estate when you die. The tax is based on the value of your estate. Each state handles its estate tax differently. It’s beyond the scope of this chapter to explain each state’s tax. I will focus on the federal estate tax.

California doesn’t levy a separate estate tax on the estate. It takes its tax out of the federal estate tax. So if you live and die in California, you really only have to consider the federal estate tax.

Not every estate will have to pay taxes. There is no tax if your estate is below the exemption amount. Here are the exemption amounts and tax rates since 1997:

Year

Estate Tax Exemption

Top Estate Tax Rate

1997

$600,000

55%

1998

$625,000

55%

1999

$650,000

55%

2000

$675,000

55%

2001

$675,000

55%

2002

$1,000,000

50%

2003

$1,000,000

49%

2004

$1,500,000

48%

2005

$1,500,000

47%

2006

$2,000,000

46%

2007

$2,000,000

45%

2008

$2,000,000

45%

2009

$3,500,000

45%

2010

No Tax

No Tax

2011

$5,000,000

35%

2012

$5,120,000

35%

2013

$1,000,000

55%

Notice it changes. In 2012, the exemption amount is $5,120,000. Unless Congress and the President do something, it will drop to $1,000,000 next year.

If you die on December 31, 2012, with a $5,000,000 estate, your family won’t have to pay an estate tax. If you die, one day later, January 1, 2013, your family would have to pay roughly $1,400,000. Isn’t this ridiculous?

For more craziness, look at 2010. There was no estate tax that year. George Steinbrenner, owner of the Yankees, died that year with a $1.2 billion dollar estate, and his family did not have to pay federal estate taxes. Lucky for them. Good timing George.

I could write a whole book on the capricious nature of the tax code, but I will keep to the topic.

Don’t Forget Life Insurance

You should also know that for estate tax purposes, your estate includes life insurance. If you were wiped out in the great recession but maintained a life insurance policy, you may have a taxable estate. Let’s say your house is underwater, you have $50,000 in savings and you have a $1,000,000 term life insurance policy. Your taxable estate would be $1,050,000.

Gift Tax

If you have an estate large enough to be taxed, couldn’t you simply gift your assets to your children before you die to avoid the estate tax? Unfortunately no. The government is on to that trick, which is why there is a gift tax.

Yes. There is a tax when you make gifts.

There are two parts to the gift tax. The Lifetime Gift Exemption and the Annual Gift Exemption.

The lifetime gift exemption is the amount you can gift during your lifetime without incurring a tax. Like the estate tax, the lifetime gift exemption has changed over the years.

Year

Estate Tax Exemption

Top Estate Tax Rate

1997

$600,000

55%

1998

$625,000

55%

1999

$650,000

55%

2000

$675,000

55%

2001

$675,000

55%

2002

$1,000,000

50%

2003

$1,000,000

49%

2004

$1,000,000

48%

2005

$1,000,000

47%

2006

$1,000,000

46%

2007

$1,000,000

45%

2008

$1,000,000

45%

2009

$1,000,000

45%

2010

$1,000,000

35%

2011

$5,000,000

35%

2012

$5,120,000

35%

2013

$1,000,000

55%

The lifetime gift exemption is tied to the estate tax. The lifetime gift exemption you use will be subtracted from your estate tax exemption. Let’s say you gifted $250,000 during your lifetime. If you pass away in 2013, your estate tax exemption would be deducted by $250,000.

2013 Estate tax exemption:                        $1,000,000

Lifetime gift exemption used:                        -$250,000

Remaining estate tax exemption:                  $750,000

Your estate tax exclusion will be reduced by the amount of the lifetime gift exemption you have used.

The second part of the gift tax is the annual gift tax exemption. This is the freebie gift.  The annual gift tax exemption has also fluctuated over the years.

Year

Annual Exclusion Amount

1997

$10,000

1998

$10,000

1999

$10,000

2000

$10,000

2001

$10,000

2002

$11,000

2003

$11,000

2004

$11,000

2005

$11,000

2006

$12,000

2007

$12,000

2008

$12,000

2009

$13,000

2010

$13,000

2011

$13,000

2012

$13,000

2013

TBD – indexed for inflation

In 2012, the annual gift tax exemption is $13,000. You can gift $13,000 to as many people as you want this year and the gifts won’t be taxed. If you are married, you and your spouse can each give $13,000 per person, or $26,000 per person.

In addition, the gift amount will not count against the lifetime gift exemption.

Let’s say you have three children and six grandchildren. You could gift each $13,000, for a total of $117,000 ($13,000 x 9) without using any of your lifetime gift tax exclusion.  And you could double the gift if your spouse does the same.

When you use the annual gift tax exemption, you will not dip into your lifetime gift tax exclusion, it is a freebie.

Next, I will discuss the opportunities and pitfalls of making gifts in 2012.

6. Revocable Living Trust

This is part 6 in my series, Estate Planning – What You Need to Know.

Part 6 – Revocable Living Trust.

The solution for probate is a revocable living trust. A revocable living trust is a legal contract you make with yourself, or, if you are married in a community property state like California, with your spouse. The trust is a set of instructions on how you want your assets to be managed if you become incapacitated and how you want them distributed when you pass away.

You, or if it is a joint trust with your spouse, you and your spouse, are the managers, or trustees, of your trust. As trustee, you have full authority over the trust assets: you can buy, sell and spend assets as you see fit, just like you would do without the trust. The difference is that the assets owned by the trust can be managed by your successor trustee if you become incapacitated or pass away.

Because there is someone already appointed and authorized to manage your affairs, there is no need for the probate court.

Here’s the example I use with my clients to make the point.

You and your wife own your home. The deed to your home names both of you as owners. When you sell your home, you will have to sign a new deed to transfer the home to the buyer.

What if you both pass away and your children need to sell your house? You and your spouse are still listed on the deed as the owners. If your children find a buyer, how will you sign the transfer deed? You’re no longer alive – you can’t sign the closing documents.

That’s when the court gets involved. For the title company to complete the sale of your house, it needs an order from the court stating that someone (the executor) has the authority to sign the deed on your behalf. This is done in probate court.

In other words, your children can’t sell your house without going through the court and getting an order from the judge. That is a real hassle.

However, if you’ve established a living trust, and you’ve transferred title of your home to your trust, then the trust owns your home. It owns your home not only when you are alive, but also when you die. Therefore, your family will not need the court order to sell your house. Instead, the person you named in your trust as your successor trustee can sign the new deed on behalf of the trust to sell your home.

Bottom line: The main benefit of a living trust is it allows your family to manage your affairs “in-house” without court approval and the costs and delays of the probate.

Next is Part 7, Funding Your Trust.

 

5. What If I Only Have a Will?

This is part 5 in my series, Estate Planning – What You Need to Know.

5 – What If You Have Only a Will?

So maybe you’ve done some planning. You’ve executed a will. Is that enough? Maybe not.

The will states who gets your assets, and if you have young children, it names the guardians to raise your children. That’s good and it’s certainly better than no plan. However, the downside to a will is your family or friends may have to take your estate through probate, and they probably won’t be happy about it.

Probate is a court procedure where an attorney will file your will in the court’s public records, notify any existing and potential creditors and heirs to make a claim against your property, and when the time for making a claim has expired, seek the court’s permission to distribute your remaining assets. The process takes about nine months to a year for a small estate and much longer for a large estate.

Probate Attorney Fees

The attorney and the executor are each entitled to statutory probate fees. In California, the fees are significant. California Probate Code establishes the fees for the attorney and the executor as follows:

Estate Value

Attorney Fees

Executor Fees

Total

$100,000

$4,000

$4,000

$8,000

$200,000

$7,000

$7,000

$14,000

$300,000

$9,000

$9,000

$18,000

$500,000

$13,000

$13,000

$26,000

$750,000

$18,000

$18,000

$36,000

$1,000,000

$23,000

$23,000

$46,000

$2,000,000

$33,000

$33,000

$66,000

These are the statutory fees. Family members can negotiate with the attorney for a different amount, but this is the standard used in most cases.

Public Record

In addition to the delay and costs, probate also makes a public record of your will and the probate proceedings. Anyone can look up your public record and see what you owned, what you owed, the name, age and address of your children and who gets your assets.

Did you ever notice that when certain celebrities die, within days, the media reports what the celebrity owned and who will inherit the assets? Over the last few years, we learned about the estate of Jacqueline Onassis, James Brown, Michael Jackson and Whitney Houston. You’re probably not a celebrity, but do you want your very personal information made a public record?

Next is Part 6, Revocable Living Trust.

3. What if You Don’t Have an Estate Plan?

Here is Part 3 of my series, Estate Planning – What You Need to Know.

What if You Don’t Have an Estate Plan?

Simply put, if you don’t have a will or a revocable living trust, then when you die, your assets will go according to state law found in the probate code.

If you live in California it goes like this:

  • if you are married, your assets will go to your spouse.
  • If you have children, your separate assets will go either one-half to your spouse if you have one child, and one-third to your spouse if you have more than one child. The rest will go to your child(ren).

If you are not married and don’t have children, your assets will go to your next of kin in the following order:

  • to your parents, if they are alive, then
  • to your siblings, if they are alive, then
  • to your aunts and uncles, if they are alive, then
  • to your cousins, if they are alive, then
  • to your crazy fourth cousin twice removed, if he isn’t alive, then
  • to the state. Believe it or not (or course you can believe it) if  there are no living family members, the state will take your assets. The sophisticated legal term for this is “escheat” – your estate will escheat to the state.

You get the picture. If you don’t have a will or a revocable living trust which states how you want your assets distributed, you have what is called an Intestate estate. Intestate estates are distributed according to the state probate code.

Conservatorship

It’s bad enough to rely on the state to distribute your assets when you die, but it’s even worse to rely on the state to manage your assets while you are alive.

If you become incapacitated, which means you are no longer capable of managing your affairs, e.g. dementia, then someone else must manage your assets for you. For that someone to manage your assets, you must have already signed a Durable Power of Attorney.

A durable power of attorney is a document that gives the person you name the authority over your assets, like bank accounts and real property, if you become incapacitated. The person you name, your Agent, can take the durable power of attorney to your bank and get access to your accounts to take care of you – pay your bills, etc.

However, if you did not sign a durable power of attorney, no one will have the authority to manage your affairs. And once you become incapacitated, it’s too late to sign a durable power of attorney because you are incapacitated. Incapacitated people cannot sign legal documents.

So now what? Your loved ones will have to hire an attorney and petition the court to appoint one of them or someone the court chooses as your Conservator. A conservator is a person authorized by the court to manage your affairs, and in many cases must submit an account of her activities to the court for the judge to review. It is an expensive, tedious and nightmarish solution, which could have been simply avoided if you had signed a durable power of attorney.

Bottom line: If you don’t have an estate plan, state law will determine who gets your stuff, and if you become incapacitated, the court may end op overseeing the management of your assets.

Next up is Part 4.  Why You Need Guardians If You Have Young Children.