In the United States, every taxpayer’s estate is potentially subject to federal gift and estate taxes upon the death of the taxpayer. In addition, some states also impose a state level estate tax on the estate of a decedent. Failing to understand the impact that estate taxes can have on your estate could result in the loss of a significant portion of your estate assets after your death. Consequently, your loved ones will lose out on a significant portion of the assets you intended to leave for them. The key to making sure this doesn’t happen to your estate is found in understanding how gifts and estate taxes are calculated and working with an experienced New York State estate planning attorney to incorporate tax avoidance strategies into your comprehensive estate plan as early in your life as possible.
What Are Federal Gift and Estate Taxes?
The federal gift and estate tax is essentially a tax on the transfer of wealth. When a taxpayer dies, the taxpayer’s estate must go through the legal process known as probate. One of the purposes of probate is to ensure that federal gift and estate taxes are collected from the estate before estate assets are passed down to beneficiaries and/or heirs of the estate. The tax is levied on the combined value of all qualifying gifts made during the taxpayer’s lifetime and the value of all estate assets at the time of death. Historically, the tax rate fluctuated on a regular basis; however, the American Taxpayer Relief Act of 2012 (ATRA) permanently set the gift and estate tax rate at 40 percent. As you may well imagine, absent any exemptions, deductions or other adjustments, an estate could lose almost half of its value to the tax.
To illustrate how the tax is calculated, assume that Bob recently died. Bob was married to Mary at the time of his death. During his lifetime, Bob made gifts of assets to his children collectively valued at $3 million. At the time of Bob’s death, Bob also owned assets valued at an additional $5 million. So far, Bob has a taxable estate of $8 million. Without any further adjustments, Bob’s estate would owe a staggering $3.2 million in federal gift and estate taxes.
The Lifetime Exemption
Fortunately, each taxpayer is entitled to make use of the lifetime exemption. Although this also fluctuated wildly in the past, ATRA set the lifetime exemption at $5 million, adjusted annually for inflation. For 2017, the exemption amount is $5.49 million. Bob’s taxable estate after deducting the lifetime exemption is now $2.51 million. Bob’s estate now owes $1, 004,000 in federal gift and estate taxes.
The Unlimited Marital Deduction
To avoid paying any taxes, Bob could use the unlimited marital deduction which allows a taxpayer to gift an unlimited amount of assets to a spouse, tax free; however, if Mary also owns valuable assets this could serve only to prolong the payment of taxes as it may over-fund Mary’s estate.
The Annual Exclusion
One thing Bob could have done to lower the value of his taxable estate is to make yearly gifts using the annual exclusion. The annual exclusion allows a taxpayer to make yearly gifts valued at up to $14,000 to an unlimited number of beneficiaries tax-free. Moreover, these gifts do not count toward the taxpayer’s lifetime exemption limit. For example, if Bob had started using the yearly exclusion ten years prior to his death and made yearly gifts to his four children, Bob could have transferred $560,000 tax-free and saved over $200,000 in taxes.
State Estate Taxes
Some states, including the State of New York, also impose an estate tax. Like its federal counterpart, New York also gives each taxpayer a lifetime exemption. In April 2017, the exemption amount will be $5.25 million and for 2018 and beyond the exemption amount will equal the federal exemption. The tax rate in New York varies between five and 16 percent.
The key to avoiding both federal and state estate taxes is to work with your New York estate planning attorney to include tax avoidance strategies in your estate plan.
If you have questions or concerns about federal and/or state estate taxes in New York, contact an experienced New York State estate planning attorney at the Law Offices of Kobrick & Moccia by calling 800-295-1917 to schedule your appointment.