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Understanding Estate Taxes

Today is income tax day. So probably the last thing you want to hear about is estate taxes, right? However, there are a lot of misconceptions about estate taxes, and I wanted to take just a few minutes to clear them up and help you understand estate taxes better.

 What is Estate Tax?

Estate tax is much different than income tax. Whereas income tax is a tax on the income that you earn each year and reluctantly give to Uncle Sam, estate tax is a tax on your right to transfer the property that you own at your death. When you pass away, your estate consists of all of the assets that you own, including your home, your bank accounts, your investments, your 401(k) and other retirement assets, any life insurance owned by you, and any other assets titled in your name at the date of your death. Your gross estate for estate tax purposes is the combined fair market value of all of these assets as of the date of your death. As a result of the American Taxpayer Relief Act (“Act”), which was passed into law on or about January 1, 2013, the estate tax exemption is $5,340,000 for people that pass away in 2014. This means that this year you can pass away with up to $5,340,000 in your estate without having to pay any estate taxes at all. And this amount is indexed for inflation, so it will continue to increase each year over time. If you passed away in 2014 and your estate is over this amount, then your beneficiaries would have to pay 40% for every dollar over this amount.

Does My Spouse Get His/Her Own Exemption Amount Too?

Yes, in 2014, your spouse also gets his or her own estate tax exemption of $5,340,000. Thus, if both of you passed away in 2014, you could pass up to $10,680,000 estate tax free to your beneficiaries. For married couples, there are a few other concepts that are also important. First, because of the so-called “unlimited marital deduction”, you can pass on as much as you want to your spouse without using up any of your estate tax exemption amount at all. This may allow you to pass on additional amounts to your other beneficiaries. In addition, because of “portability”, which is now permanent under the Act, your spouse can use your unused estate tax exemption amount if you pass away this year and do not use all of it. I will discuss the concept of “portability” in more detail in another blog, but this adds tremendous flexibility to ensure that you and your spouse can use all of the estate tax exemption amounts for both spouses.

What if I Give My Assets Away During My Lifetime Instead?

The Act also re-unified the lifetime gift exemption amount with the estate tax exemption amount, so that both are $5,340,000 for 2014. This means that, with the exception of the annual exclusion gifts which I will discuss in a moment, you can gift away up to $5,340,000 gift tax free during your lifetime or you can pass on up to $5,340,000 estate tax free to your beneficiaries after your death, or any combination of both. However, if you pass away in 2014, the total amount of your unified estate tax exemption amount and gift tax exemption amount is $5,340,000. The annual exclusion gifts are an exception to this rule. I call it “off the radar” gifting. In 2014, you can give up to $14,000 per donor, per donee, each year to as many people as you want. This means a father of four children, could give $14,000 a year to each of his children, or $56,000, each year without any gift or estate tax consequences. There are also a few nuances to annual exclusion gifting that I will cover in a separate blog. Finally, if you gift someone an amount over the $14,000 this year, then you will either need to pay the gift tax at 40% of the excess amount or use up some of your lifetime gift tax exemption.

So Now You Know . . .

If your estate is large enough to be over the estate tax exemption amounts, the good news is there is planning that can be done to reduce or eliminate this estate tax liability altogether. However, even if you do not have an estate tax issue with your estate, proper planning is still critical avoid probate, handle incapacity issues, provide creditor protection for your beneficiaries, and provide ongoing management of your assets for your beneficiaries after you are gone.

 If you need help, please call me today – 602.277.7000

John Even

Our firm has helped hundreds of families just like yours handle a wide variety of estate planning, business planning, probate, and elder law issues. When families or business owners are not getting along, we can also handle any disputes and litigation related to their businesses, wills, trusts, guardianships, or conservatorships. Please give me a call, so that I can help you work through these difficult issues with confidence.

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