An estate tax taxes the estate. In other words, the property of the person who has died is taxed based upon a total aggregate amount less any exemptions.  Compare this to an inheritance tax, used in some states, where the tax taxes the heirs. In Texas, we talk about estate taxes. For example, someone dies leaving $5,000,000.00.  It is the $5,000,000.00 which is taxed less exemptions. In 2009, each person is allowed a $3,500,000 exemption. In 2010 the estate tax will be repealed - no federal estate taxes for this year.  In 2011 the estate tax will be reinstated at 1,000,000.00. The maximum tax rate being 55%.  Currently there are pending bills that would repeal the estate tax permanently.  However, passage is not probable.

In states which use the inheritance tax, a tax is placed upon each heir’s share. If an estate leaves $5,000,000.00, the federal government will get its share first from the gross estate, then the state will come back and tax each heir for the amount that they actually received. If child A receives $1,000,000.00, then child A’s inheritance will be taxed.  If child B receives $500,000.00 then it is child B’s $500,000 that will be taxed. Texas does not use the inheritance tax formula.

Some states also impose a probate tax.  A probate tax is a tax imposed upon property which passes through the probate process. Texas does not use this formula either.

The Unlimited Marital Deduction

The Unlimited Marital Deduction - all assets pass to surviving spouse without tax.  It does not matter how big the estate or how small, the entire estate can pass to the husband or wife without tax. If you think about it, sound public policy dictates that each spouse should be able to leave as much of their property as they want to the other spouse without penalty.  Since spouses are under a duty to support the other spouse and since it is public policy to encourage the marital relationship, public policy dictates that we should not tax the marital relationship.

Problem: If you use the Unlimited Marital Deduction to pass all of your property to your spouse, then you will loose your gift tax exemption.  Read further.

 Gift Tax Exemption

The Unlimited Marital Deduction has a strong disadvantage. The first to die looses their gift tax exemption.  If a deceased passes his or her estate outright to their spouse, without the benefit of effective estate planning, then upon the death of the last spouse to die the entire gross estate will be taxed less one person’s gift tax exemption. 

Thus, our government’s most important reason to allow for an unlimited marital deduction is to increase revenues..  Effective estate planning, takes advantage of both spouses’ gift tax exemption in order to realize $1,300,000.00 (2 * 650,000.00) in taxable savings.  The examples below may help illustrate the problem.

The use of a "A-B" trust, also known as a QTIP Trust, is one of the most commonplace and effective means by which spouses can insure that both have the benefit of their tax equivalent exemptions. Click on the "Trusts" button at the left to learn more about trusts.

An Annual Gift Program

The Double/Double and its’ Permutations –

The Tax Fee Gift

Taking advantage of the annual gift tax exclusion is one of the most effective tax strategies you can use to minimize your estate taxes. Each individual is entitled to give up to $10,000 per year to any other individual without tax. 

You can give $10,000.00 per year to each of your children, family members, and/or friends without tax.  Your spouse can also give $10,000.00 per year to each of your children, family members and/or friends without tax. Do some math. You and your spouse can give $40,000.00 per year to your son or daughter and their spouse without tax. Failure to use this simple device is like  giving the US Government $3,000.00 – 5,500.00 for every $10,000.00 you do not give away. 

If you have estate tax exposure and if you can afford it, then you should take advantage of this tool. Colloquially, we call it the Double/Double, Double/Single, Single/Double, and Single/Single.

1. Double/Double: Each year, Dad gives $10,000 to his son and Mom gives $10,000 to her son. They also each give their daughter-n-law $10,000.00 per year.  Added up, Mom and Dad are passing $40,000 tax free each year to their son’s family.

2. Double/Single: Mom and Dad give $10,000.00 each to son for a total of $20,000.00 passed tax free each year.

3. Single/Double: Since Dad has passed away, Mom gives $10,000 to son and $10,000 to daughter-n-law each year. Adding the son’s and daughter-n-law’s gift together, Mom is passing $20,000.00 to this family tax free each year.

4. Single/Single: Mom gives $10,000 to son each year tax free.

      Caveat: Don’t put yourself in the poor house. If you decide to use this estate planning tool, be sure not to give away so much that it will leave you destitute.  Further, this is not a device to be used for Medicaid planning. 

      Appreciating Assets: This formula is also very effective for the passing of highly appreciating assets.  If you own stock, then you have probably enjoyed substantial gains in the stock over the last few years.  Use the forgoing formulas and pass the stock.  By moving highly appreciating assets from your portfolio, you also remove the appreciation from your estate. So if you pass $10,000.00 worth of stock this year which may be worth $20,000.00 in three years, then you have saved your estate an additional $10,000.00 of taxable value.  This is true for any asset which will experience appreciation.

      I Do Not Like My Child’s Spouse: Families come in all shapes and sizes. Some get along like the best of friends. Others, barely tolerate one another.  If you intend to make cash gifts, then consider you son or daughter in law. 

      We recognize that many parents may not have a good relationship with their children’s spouses. However, if your son or daughter is struggling to make ends meet, or to start a family, or if they have suffered physical or financial setback, then you should consider the in-law for the cash gift. It is true that these monies will be their separate property because it is a gift, however, recognize that the beneficiary of the money is your child’s family.  It might be used to pay down the mortgage, make investments, redecorate the grandchild’s room, or take the family to a long needed but unaffordable vacation. If they use the money unwisely, then you can always refuse to give them the gift the following year. You never know, you may find that it improves your relationship with your in-laws. Warning: do not give in-laws a portion of the family business unless you are very secure in your child’s relationship with their spouse. This could create a significant family difficulty.

      Christmas Not:  January 1 is the time to make the gift. It is best to make the gifts on the first day of each year. Since the taxable year starts on January 1, you want to make sure that you take advantage of that year’s gift. A lot of families wait until Christmas to distribute the yearly gift. Though with the best of intentions and the spirit of the season, they are constantly betting on dying between December 25 and December 31. The problem is, they have waited until the last moment of that year to make the gift. If the parent were to die prior to December 25, then they would lose that year’s gift. As mentioned above, this is a minimum cost of at least $3,600.00 to the estate.

      Family Limited Partnerships, Subchapter S corporations, and limited liability companies.  It is not just cash, stocks, bonds, or mutual funds that may pass under the $10,000.00 per year exclusion.  An interest in a closely held company may also pass. If your family owns a family business or has the resources by which to create one, then the $10,000.00 gift is an excellent way to pass large portions of property. Divided interests in family businesses do not have a market. Who would be willing to buy 10% of the Smith Laundry and Dry Cleaning Co. when it is not publicly traded and the other 90% is owned by the rest of the Smiths?  Not too many people. This causes shares in such businesses to become substantially devalued. Share price is dependent upon the market. If a ready market is unavailable, then the share price falls. Thus, a $10,000.00 gift of shares in a family business will represent an interest that is worth more than the $10,000.00, sometimes, substantially more.  Again, Do not give shares of closely held businesses to in-laws.

      Crummey Trusts. Many years ago the Crummy Family, wanted to use the $10,000 annual exclusion to fund a trust for the benefit of their family members. However, they also wanted to limit family members access to the money.  In order to qualify for the gift tax exclusion, language was inserted in their trust which allowed beneficiaries a limited period of time in which they could withdraw the money. If they did not withdraw, then the funds would remain tied up in trust. The case went to Court. The Court ruled that since the beneficiaries had an unlimited present right of access for a limited time, then the gifts qualified for the gift tax exclusion.  The obvious disadvantage to the Crummey Trust is beneficiaries could withdraw the money against your wishes.  The only way to protect against this is to indicate to your beneficiaries that you have a strong desire not to have the funds withdrawn.  

If you have a legal question or want more information about wills and other testamentary instruments, please contact us by telephone, e-mail, or you can complete the form field below and hit submit.