What is the Estate Tax?
The estate tax is a tax on a decedent’s assets at the time of his or her death. All assets held by the decedent are included in determining the decedent’s taxable estate, including real estate, securities (stocks and bonds), bank accounts, retirement accounts, assets in a living trust, and sometimes life insurance. Generally, the status of the beneficiary is irrelevant; if a decedent had assets greater than the amount excluded from estate taxes (the “applicable exclusion amount”), there will be a tax. However, gifts to charities and spouses, who are citizens of the U.S., are free of tax.
The estate tax is due nine months after the decedent's death. The estate tax is separate from and in addition to any income taxes that are due annually on April 15.
The estate tax applies to estates greater than $5 million, indexed for inflation beginning in 2011 and doubled beginning in 2018. In 2023, $12.92 million is protected from estate tax. The rate on assets greater than $12.92 million is 40%.
California does not have a separate inheritance tax. Previously, the federal government allowed the states to “pick up” a portion of the estate tax for themselves. Effective 2005, no estate or inheritance tax is being forwarded to the states. Some states have established their own inheritance or estate tax. A California constitutional amendment would be required for there to be a new California inheritance tax.
What is Estate Tax Portability?
Portability (also known as DSUE – “Deceased Spouse’s Unused Exclusion”) is a concept that entered the law in 2011 and became permanent with the American Tax Relief Act of 2012 (“ATRA”). It allows a surviving spouse of a married couple to utilize his or her deceased spouse’s unused applicable exclusion amount, effectively increasing the amount that the surviving spouse can gift or bequeath to family or friends tax free.
Example: Sam died in 2023, leaving an estate of $2 million to his children. His wife, Miriam, is quite wealthy and does not need any of Sam’s assets to live a comfortable life. She realizes that Sam could have gifted up to $12.92 million under the tax code, but only had $2 million to give. She files an “Estate Tax Return” and claims Sam’s lost $10.92 million in available exemption. At Miriam’s death (also in 2023), she is able to utilize her $12.92 exclusion and Sam’s lost $10.92 exclusion to protect more than $20 million from estate taxes. Her children will only have to bear estate taxes if her estate is greater than $23.84 million.
Portability is only available to persons who are legally married and must be claimed using a timely-filed Estate Tax Return following the deceased spouse’s death. It cannot be used twice if a person has two deceased spouses and does not protect the growth of a deceased spouse’s assets. It is often used in conjunction with one of the trusts for a married couple, described in this website.
What is the Gift Tax?
The gift tax is an additional tax designed to discourage wealthy persons from making large gifts to family members during their lifetime, to avoid an estate tax on the same assets at death. Each person may give up to $12.92 million during his lifetime without paying any gift tax. On April 15 of the year following the gift, the donor must file a “Gift Tax Return” to record his use of a portion of his $12.92 million exemption. Any amount used during lifetime will reduce the applicable exclusion amount available at the donor’s death.
In addition to the lifetime exemption, a donor may make gifts of up to $17,000 (2023) to anyone in each calendar year. Wealthy people with large families can give hundreds of thousands of dollars away every year by use of the $17,000 exemption. The donor must be very careful if he intends to gift assets that are hard to value (such as real estate or business interests) or wishes to make gifts to minors.
How should I plan if my Estate will not be subject to Estate Taxes?
Since the credit from estate taxes is now $12.92 million per person, most estates (even in Los Gatos, Saratoga, and western Silicon Valley) are not subject to the estate tax. However, this does not mean that proper planning can be ignored. If you fall into any of the following categories, you should consider establishing a living trust that will focus on controlling the beneficiaries of your estate and avoidance of probate, rather than directed by tax planning:
- Have Young Children
- Have Children from Prior Marriages or Relationships
- Own Substantial Separate Property
- Would Prefer to Leave Your Property to Non-Family Members
- Have Concerns about the Persons who may Manage your Estate
- Own Real Property (especially if located in multiple states)
Trusts can be drafted to provide an education fund for your children, but leave the bulk of the funds in the care of a trusted relative or friend until each child is of a more mature age (such as 25 or 30). If you have substantial separate property, it may be to your advantage to structure a trust that will provide health care and maintenance to your spouse, but leave any remaining principal at your spouse’s death to your family line (not your spouse's family). Please contact me to discuss your particular concerns about your family, so that together we can craft an estate plan that truly reflects your wishes.
** Any information contained in this website was not written, is not intended to be used, and cannot be used by any taxpayer for the purpose of avoiding any federal tax penalties that may be imposed upon the taxpayer. (See IRS Circular 230) **