You know that you’re facing bumpy times when the IRS, a black hole of incomprehensible rules, says on its own website that estate and gift taxes are “considered to be some of the most complicated in the Internal Revenue Code.”
Is that like an airline pilot blandly telling passengers there might be “some chop” ahead? Followed promptly by an in-flight experience akin to a piñata flogging?
The current top tax rate for estates exceeding $5 million is 35 percent (for the years 2011 and 2012) after Congress passed and President Obama signed a Tax Relief Act in December. In 2013, that rate will rise to 55% on estates exceeding $1 million, absent any further legislation.
Despite ongoing rhetoric on Capitol Hill, estate-tax expert Julie K. Kwon says don’t look for more help from lawmakers on the issue right now. While changes can occur at any time, it is wise to use the latest rules that are in place at the time of any actual transaction.
Kwon, who chairs the American Bar Association’s Income & Transfer Tax Planning Group, says she would be “shocked if Congress were to do anything this year before the next election.” She points to the pressure of other legislative priorities and the reluctance of congressional members to expend further political capital on the issue.
“The current $5 million exemption is a temporary and unusually high exemption amount,” Kwon notes. “The fluctuations in federal exemptions and rates, together with the need to coordinate with separate state death taxes that many states have adopted, complicate planning.”
All these shifting tax rules and continuing debates, Kwon says, simply “heighten the need for individuals to consult with expert advisors and to monitor the effect of such changes on their planning to avoid unexpected results.” Kwon is a partner with McDermott Will & Emery LLP and is based in California at the law firm’s Silicon Valley office.
She adds, “Unfortunately, it is impossible to predict where these numbers will settle out at either the federal or state level.”
One look at the IRS website for estate and gift tax information may overwhelm you enough to take Kwon’s advice and dial an estate attorney. But one can always try flying solo through IRS information overload and check out the feds’ estate page. It’s heavy duty reading, but you’ll find a lot of valuable information if you take the time to go through it.
The “gross” estate includes real estate, notes, cash, stocks, bonds, mortgages, insurance monies received, property and more. Various factors will affect how the tax is determined, i.e. marital deductions, possible estate taxes in your particular state (and these are in the process of evolving as well), administrative expenses, any claims or liens against the estate, funeral costs, charitable donations, and any other outstanding debt. Ultimately, the tax must be paid within nine months of the death (this is with an extension). In many instances, due to poor planning and tight deadlines to pay the taxes, heirs are often forced to sell property to pay this tax bill. While you can’t avoid a tax altogether, you can reduce the burden with careful planning before the time comes.
It also matters who your beneficiaries are. Did you realize that skipping a generation in your bequest incurs a double tax? When you “gift” over $5 million to grandchildren, the IRS considers this “two gifts in one” and charges a 35% tax on the gift twice.
One way to reduce the tax bill, for example, is to distribute property during your life, rather than afterwards. You can give an unlimited number of $13,000 gifts of cash and other property tax-free, with each individual receiving no more than $13,000 in a calendar year. Obviously, this is more advantageous for smaller estates than larger ones where these amounts make less of an impact.
Increased exemption amounts are also creating opportunities that may not last so it is critical to examine the options now. There are ways to create or supplement existing trusts to allow the transfer of wealth without being subject to the same degree of taxation. For example, grantor trusts (a type of irrevocable trust) provide an effective mechanism to achieve this. Grantor Retained Annuity Trusts (GRATS) are advantageous in low interest rate environments with payout rates based on IRS published interest rates at the time of the funding. The list goes on with choices and the time to make them is now.
For a smoother trip in estate planning, you’ll find a public service of sorts on McDermott’s site: a plain-English version (or at least a lawyerly version of plain English) on what’s going on in estate law. It might just be your Kayak or Orbitz alternative to the IRS.
What does this mean to you? Since the ultimate goal is to leave as much of your estate to your chosen beneficiaries as possible, it is critical to engage in some level of strategic estate planning. Obviously, the larger your estate, the more complicated it becomes and will most likely require assistance from a professional in minimizing the tax burden upon your estate and maximizing what your beneficiaries receive. Clearly, it is best done sooner rather than later.