One of the first orders of business when you are planning your estate is going to be an inventory of your assets. Clearly, regardless of the exact nature of your financial situation, you have to identify exactly what you have to give to your loved ones.
For people who have been particularly successful, this inventory is going to have an added level of significance. If you have been able to accumulate a significant store of wealth, you may be subject to the federal estate tax, and you must evaluate your level of exposure.
To do this, you would compare the value of your estate to the amount of the federal estate tax credit or exclusion. In 2016, the federal estate tax exclusion is $5.45 million, and the maximum rate of the tax is 40 percent.
The $5.45 million exclusion is the amount that you can transfer free of taxation. Anything that you transfer that exceeds this amount would potentially be subject to the death tax.
Estate Tax Marital Deduction
Now that we have explained the basics about the federal estate tax, we can get to the spousal dynamic. There is a marital estate tax deduction that allows you to leave unlimited assets to your spouse free of taxation. You would not be using any of your available $5.45 million exclusion to leave a tax-free bequest to your spouse.
However, to use the unlimited marital estate tax deduction, your spouse must be a citizen of the United States. The unlimited marital deduction is not allotted to non-citizen spouses, and there is a very logical rationale behind this stipulation.
The tax man is largely unconcerned about the existence of the unlimited marital estate tax deduction, because he will get his money eventually.
Imagine the scenario that would exist if you are married to a citizen of the United States. For the purposes of this example, let’s say that you leave a $25 million bequest to your spouse tax-free.
Your surviving spouse would then be in possession of an estate that is subject to the estate tax. The tax would still be looming.
On the other hand, if the unlimited marital deduction was allotted to a non-citizen spouse, the tax man may never see any money. The surviving spouse could return to his or her country of citizenship with a tax-free inheritance, and this individual would never face any estate tax exposure in America.
Portability
Since we are talking about the estate tax as it applies to spousal relationships, we should also touch upon the matter of estate tax exclusion portability.
The estate tax is portable between spouses. This means that a surviving spouse could use the exclusion that was afforded to his or her deceased spouse.
The survivor would have two exclusions, so in 2016, this would equate to a total exclusion of $10.9 million.
Federal Gift Tax
In addition to the federal estate tax, there is also a federal gift tax in the United States.
When the estate tax was first enacted in 1916, people used to give lifetime gifts to their family members to avoid the tax. A gift tax was enacted a few years later to close this loophole. It was briefly repealed, but it returned for good in 1932.
The gift tax and the estate tax are unified, so the $5.45 million exclusion that we have in 2016 is a unified exclusion. It applies to lifetime gift giving along with the value of your estate.
The unlimited marital estate tax deduction also extends to lifetime gift giving, since the gift tax and the death tax are unified.
Estate Tax Efficiency Strategies
When you are evaluating your position relative to the transfer tax exclusion, you have to analyze the value of any real property that you may own. Here in Indiana, there are many people who own vast tracts of farmland, and the land can be quite valuable. The “land rich, cash poor,” scenario can come into play, but the tax man has no sympathy.
If the value of your estate exceeds the amount of the estate tax exclusion, you do not necessarily have to be resigned to pay taxes on every penny that is technically taxable. You can position your assets in various different ways that would provide tax efficiency.
The nature of your resources and your long-term estate planning objectives will dictate the appropriate course of action. Our firm can help if you would like to discuss your options with a licensed estate planning attorney.
To schedule a no obligation consultation, call us at (317) 684-1100 or send us a message through our contact page.
Paul A. Kraft, Estate Planning Attorney
Mr. Kraft assists clients primarily in the areas of estate planning and administration, Medicaid planning, federal and state taxation, real estate and corporate law, bringing the added perspective of an accounting background to his work.
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