Federal Estate Tax: Basics and 2015 Update

What is the Federal Estate Tax?

The Federal Estate Tax is a tax on your right to transfer property at your death. It consists of an accounting of everything you own or have certain interests in at the date of death. The “fair market value” of these items is used -- not necessarily what you paid for them or what their values were when you acquired them. The total of all of these items is your "Gross Estate" which may consist of cash and securities, real estate, insurance, trusts, annuities, business interests and other assets.

Once you have accounted for the Gross Estate, certain deductions (and in special circumstances, reductions to value) are allowed in arriving at your "Taxable Estate." These deductions may include mortgages and other debts, estate administration expenses, property that passes to surviving spouses and qualified charities. The value of some operating business interests or farms may be reduced for estates that qualify.

After the net amount is computed, the value of lifetime taxable gifts is added to this number and the tax is computed. The tax is then reduced by the available “unified credit”.

Most relatively simple estates – those consisting of cash, publicly traded securities, small amounts of other easily valued assets, and no special deductions or elections, or jointly held property -- do not require the filing of an estate tax return. A filing is required for estates with combined gross assets and prior taxable gifts exceeding $5,430,000 in 2015.

2015 Estate Planning and Tax Update

The key provisions of the American Taxpayer Relief Act of 2012 (“Act”) relating to the Federal Gift Tax, the Federal Estate Tax and the Federal Generation-Skipping Transfer (GST) tax in 2015 include the following:

Permanent Exemption Amounts and Increased Maximum Tax Rates

The Federal Gift Tax exemption amount is the total amount of taxable gifts (i.e. gifts that do not qualify for the annual exclusion ($14,000 in 2015) or the unlimited medical or educational gift tax exclusions) that an individual may make during his or her life-time without incurring a Federal Gift Tax.

The Federal Estate Tax is imposed on property transferred at death to the extent that the value of such property (other than property transferred to a surviving spouse or to charity) exceeds the unused portion of the decedent's Federal Estate Tax exemption amount. Lifetime taxable gifts reduce the Federal Estate Tax exemption amount available at death.

The Federal Generation-Skipping Transfer Tax applies to transfers made to “skip persons” -- grandchildren or more remote descendants or unrelated individuals who are more than 37.5 years younger than the donor - and to gifts made to GST Trusts which have skip persons as beneficiaries and/or "skip" the Federal Estate Tax on the death of a younger generation beneficiary.

The Act permanently unified the Federal Gift Tax exemption amount and the Federal Estate Tax. The total exemption amount for taxpayers who die in 2015 is $5,430,000. The Act also permanently set the Federal GST tax exemption at an amount equal to the Federal Estate Tax exemption amount and the Federal Gift Tax exemption amount, adjusted annually for inflation. The Act increased the maximum tax rate from 35% to 40% for gifts and transfers made during lifetime and for decedents dying on or after January 1, 2013 with Estates in excess of the exemption amount.

Permanent Portability of Unused Exemption Between Spouses

The Act made permanent the ability of a Personal Representative of a deceased spouse's Estate to elect to allow his or her surviving spouse to use the deceased spouse's unused exclusion amount remaining at death (referred to as "portability"). The deceased spouse's unused exclusion amount is in addition to the surviving spouse's Federal Estate Tax exemption amount and Federal Gift Tax exemption amount. To make the portability election, an Estate and GST Tax Return must be filed for the deceased spouse's Estate. After the election is made, the surviving spouse may apply the deceased spouse's unused exclusion amount received from the Estate of his or her last deceased spouse against any tax liability that would otherwise arise from subsequent lifetime gifts and/or transfers at death. The effect of portability is that upon the death of the second spouse, a larger amount of the estate of the deceased second spouse will pass to his or her beneficiaries free of the estate tax.

It has been standard practice for many years that estate planners and their clients included both a credit shelter trust (funded by the applicable exclusion amount) and a marital deduction trust (receiving the balance of the estate left after using the exclusion amount) in the estate plans. Now, with that the applicable exclusion amount is $5.43 million, if a client’s credit shelter trust were funded with the full $5.43 Mil, if the estate of the deceased’s spouse is valued at less than the applicable exclusion amount, there might be nothing left in the estate to fund the marital deduction. In this situation, the surviving spouse would not receive anything outright or through a marital deduction trust. The estate would be consumed by the credit shelter trust – probably not what was intended in documents draw years ago.

However, there are a number of ways to deal with this situation, if confronted while the spouses are alive and in good health. In light of the recent tax changes, you may wish to contact a member of our Estate Planning team to confirm that your estate plan and/or gifting plan continues to be appropriate. It may be time for an estate planning check-up!