Happily, 2014 continues to bring stability in the federal estate, gift and generation skipping taxes. For decades these taxes have been used as a political football, bouncing up and then down as politicians used the tax to drum up votes…and their campaign funds…rather than address the tax in a reasonable manner. Finally, things seem to have fallen into place and we can make long-term plans for our clients without guesswork. Of course things can always change, but the politicians have moved onto other issues, and the taxes now effect so few people, the political will to make change has dissipated.
Under the current rules, the federal estate tax exemption protects the vast majority of families from paying any federal estate tax. And, because the federal estate tax exemption is adjusted, over the years inflation will not grow estates so they are subject to the tax. For now, only the most wealthy families are subject to the estate tax and the number of federal estate tax returns Form 706 filed continues to shrink. From 2003 to 2102 the number fell 87%.
Estate Tax in 2014
The change is due to the terms found in American Taxpayer Relief Act of 2013 (“ATRA”). Under ATRA, congress made permanent the $5,000,000 federal estate tax exemption of 2011 and indexed the tax exemption for inflation. Therefore in 2012 the exemption grew to $5.12 million and in 2013 to $5.25 million. For 2014 the exemption is $5.34 million.If your estate is below $5.34 million and you die in 2014, your estate will pay no federal estate tax. The portion of your estate that exceeds $5.34 million will be taxed, but at a flat, 40% rate. At one time the rate was incremental and would grow as high as 55%. If your estate is subject to the federal estate tax, you are in the minority, as 99.5% of estates will pass fee of this tax.
Life Time Exemption in 2014
ATRA also adjusted the federal gift tax exemption for inflation. It now grows at the same rate as the federal estate tax, so for 2014 the lifetime gift tax exemption is $5.34 million.
Generation Skipping Transfer Tax in 2014
ATRA also indexed the federal generation skipping transfer tax (“GST”) exemption for inflation, for 2014 the lifetime federal generation skipping transfer tax exemption is also, $5.34 million. Like the estate tax, the maximum GST rate for transfers that exceed the exempt amount is 40%.
Gift Tax Annual Exclusion
Part of the federal gift tax, you are given each year the ability to give any and all person a certain amount free of gift tax. This is the gift tax annual exclusion. “Annual”, as that each year you have the chance to make the gift once again. ATRA provides that the gift tax annual exclusion will also be adjusted for inflation. The 2014 annual exclusion from gift remains as it was last year, at $14,000.
ATRA also made permanent the “Portability” of unused portions of the federal estate tax between spouses. This means that as a “team”, spouses can share their $5,000,000 exemption (adjusted for inflation), so that the surviving spouse can add the unused part from the first spouse and then leave a $10,000,000 estate (adjusted for inflation) to the children. For example, if both spouses have $3,000,000 and the first spouse dies leaving all assets to the surviving spouse, that surviving spouse would have $6,000,000. Without Portability, when that surviving spouse died with $6,000,000, everything over the federal estate tax exemption would be taxed. With Portability, the first spouse’s unused $5,000,000 exemption passes to the survivor, giving the surviving spouse $10,000,000 of exemption, more than enough to cover the $6,000,000 estate.
To claim the unused exemption the first spouse’s estate must file a Federal Form 706 Estate Tax Return. This is true even if no federal estate tax is due. This is an extra expense, but for estates over the $5,000,000 exemption level, avoiding a 40% estate tax is well worth the cost of filing a return.
While the federal estate tax has Portability, the federal generation skipping tax does not. For estates that will not be spent by the children during their lifetimes, it still is worth doing some good old-fashioned dynasty trust planning to avoid GST taxation at the children’s deaths. These trusts add layers of asset protection for the children, so all the generations will appreciate the extra planning you put into place.
What does this mean for you? There are many planning opportunities created by what congress did, and did not do. Here are three of the most general opportunities to consider:
- You have the ability to set up protective trusts for your spouse and/or other family members to shelter up to $5,340,000. It is time to investigate this important and rather inexpensive way to shelter assets from divorce and legal entanglements.
- Thanks to ATRA’s inflation adjustments, if you have set up protective trusts in the past, using up all of your then existing gift tax exemption, you now have more gift and generation skipping tax exemption to use!
- Surprisingly, no changes were made to the Grantor Retained Annuity Trust (GRAT) rules. This toolallows you to pass the increase in value of assets free of estate and gift tax. If you are interested in using a GRAT to pass assets without estate or gift taxation, you might want to do so in 2014, as there have been rumblings in congress and the white house about closing down this long standing technique.
- You now have the ability to set up irrevocable trusts for your spouse and/or other family members, and fund such trusts with the annual exclusion amount of $14,000 per done per year. You can use “Crummey” powers to shift significant assets from your estate into protective trusts without notifying the IRS, all without using any gift tax exemption.
The world of taxation and asset protection is always changing. Sometimes for the good, other for the not-so-good. I will strive to keep you informed, but if you have any questions, please feel free to contact my office.