23 March 2018
In December 2010, President Obama signed legislation which reinstated the federal estate tax with more generous exemptions and lower rates. The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 raised the unified credit equivalent (the value of assets which can be transferred by lifetime gift or on death, free of tax) to $5,000,000. Similarly, the generation-skipping exemption (the tax-free amount which can be left to grandchildren and further generations) was increased to $5,000,000. The legislation also capped the tax rate on estate, gift and generation-skipping transfers at 35%. Unfortunately, these benefits were not extended indefinitely. The exemption amounts will drop to $1,000,000 and the 35% tax top rate will be come a 55% rate on 1 January, 2013 unless Congress acts to make the changes permanent. Many other Bush-era tax cuts extended by Obama, including the preferential rate on capital gains and qualified dividends, are also scheduled to expire at the end of 2012. Given the current economic climate, it is unlikely that any of these benefits will be made permanent.
For residents of New York State, the following example illustrates the effect of changing exemptions and rates. New York has a death tax with rates ranging up to 16% of value. These New York taxes are available as a deduction in determining federal taxes. So, if a decedent's estate has assets of $10 million, the total tax burden and amounts remaining for heirs can be estimated as follows:
|Death in 2011 – 2012||Death after 2012|
|Federal Estate Tax Exemption||$5,000,000||$1,000,000|
|NY Estate Taxes||$1,076,720||$1,073,720|
|Federal Estate Taxes||$1,373,148||$4,357,804|
|Total Federal and New York Estate Taxes||$2,449,868||$5,434,524|
|Net Value to Heirs||$7,550,132||$4,565,475|
Lifetime gifts can reduce tax burden
As the $5,000,000 exemption is available for lifetime gifts as well as testamentary transfers, many clients will consider making gifts before the exemption is reduced in 2013. Assuming the larger exemption amount of $5,000,000 and favourable rate will expire in 2013 as scheduled, the decedent described above may be better off making a gift to his or her heirs now, rather than waiting to make these transfers by will. This is especially true for New York residents and residents of other states which do not impose a tax on gifts. As illustrated below, a gift of $10,000,000 can result in a tax saving of over $4,000,000 when compared to a bequest at death.
|Death in 2011 – 2012||Death after 2012|
|Federal Estate (Gift) Tax Exemption||$5,000,000||$1,000,000|
|NY Taxes (no gift tax)||$0||$1,073,720|
|Federal Gift Tax||$1,296,296||$4,357,804|
|Total Federal and New York Estate Taxes||$1,296,296||$5,434,524|
|Net Value to Heirs||$8,703,704||$4,565,475|
Tax basis issues
The situation is made somewhat more complicated by the fact that, for income tax purposes, assets which are given away generally keep the same basis for determining gain or loss which the donor had when he or she made the gift. If assets are left by will, the recipient has a basis equal to the fair market value of the assets on the date of the decedent's death. Therefore, the decision whether to make a gift of artwork, for example, must take into account the potential estate tax savings against the possible tax on gain from the sale of assets by the person receiving the gift. For example, if the donor in the above example paid $7,000,000 for the artwork, the person receiving the art as a gift would have a basis of $7,000,000 and would pay capital gains tax of $840,000 (28% of $3,000,000) when the art is sold. In this case, the overall tax burden is still less than the projected tax burden on the death of the decedent after 2012.
Charitable transfers remain exempt
Many artists and collectors make gifts of their works to charitable institutions, or create a charitable foundation during their lifetime, which can receive gifts of artwork either during life or upon death. An unlimited value of art or other property can be given to a charity or charitable foundation, either lifetime or death with no estate or gift tax consequences. Charitable gifts and bequests can be made free of gift and estate tax through 2012 and thereafter.
As illustrated by the above discussion, an awareness of changing tax rules and rates is critical. Planning should be considered before 2013 to take advantage of preferred rates and high exemptions.