The State of Estate Taxes

Strategies to Help Preserve Assets for your Heirs

For the time being, only the wealthiest Americans are likely to be concerned about federal estate taxes.  In 2014, a 40% tax rate applies to taxable estate assets exceeding $5.45 million exemption amount (indexed annually for inflation).

However, 19 states and the District of Columbia currently have their own estate or inheritance taxes and some of them have far smaller exemptions than the federal government.  About 30% of the U.S. population lives in states with estate or inheritance taxes, in which case families with substantial retirement portfolios – or those who own valuable property or businesses – may want to find ways to help limit their exposure, even if they don’t think of themselves as “rich.”

Some people might choose to relocate to a state with more beneficial tax laws after they retire.  Otherwise, a few of the same strategies that have long provided some relief from federal estate taxes could also be used to help alleviate estate taxes imposed by states.

 

Tax Traps

Currently, only Delaware and Hawaii track the federal life time exemption ($5.34 million in 2014).  Six states have inheritance taxes with exemptions ranging from zero to $2 million.  The remaining jurisdictions have estate tax exemptions between $675,000 and $4 million.  Two states, Maryland and New Jersey, have both.  Top tax rates range from 9.5% to 20%.

 

Gift Transfers

Most states don’t levy gift taxes, and the federal exemption amounts are relatively generous.  Thus, giving away assets removes them from the estate and can be an efficient way to head of death duties.

In 2014, individual scan give up to $14,000 ($28,000 per couple) in cash or assets (such as stocks and bonds) as many people as they wish, without any gift tax liability.  A total lifetime exemption of $5.34 million applies to the federal gift tax and estate tax combines.  This means that any amount applied to exempt a gift from the tax during a person’s lifetime would reduce the exemption available for the estate.

Keep in mind that the original cost basis of a gifted asset carries over to the recipient, who may owe capital gains taxes when the asset is sold.  Inherited assets, on the other hand, benefit from a “step-up in basis.”  When an asset is inherited, the value adjusts to the fair market value at the date of death, so a surviving spouse might be able to gift highly appreciated assets to family members with fewer tax consequences.

Gifts to qualified charities and payments of tuition or medical expenses that are made directly to an educational institution or medical provider on behalf of someone are tax-free, and they don’t count against the annual gift tax exclusion or the lifetime exemption.

 

Portability vs. Bypass Trust

Another feature of federal tax law is “portability,” which may allow a surviving spouse to claim the deceased’s unused exemption.  At this time, Hawaii is the only state with portability rules.  Though the federal government and all states allow assets to pass to a surviving spouse tax-free 9if the spouse is a U.S. citizen), a bypass trust may be needed to take advantage of each spouse’s full exemption and shelter more assets from estate taxes. 

There are costs and expenses associated with the creation of a trust.  The use of trusts involves a complex web of tax rules and regulations.  You should consider the counsel of an experienced estate planning professional and your legal and tax advisors before implementing such strategies.

The Wall Street Journal 10/25/13