GIFT and

ESTATE TAX

BASICS

ROBERT N. NASH ILLINOIS ESTATE PLANNING ATTORNEY

Understand How Gift And Estate Taxes Work to Fully Comprehend Why Tax Avoidance Strategies

Are Commonly Employed In Estate Planning

Although the primary goal of any estate plan is to provide a legal roadmap

for the division of estate assets at the time of death, most estate plans

attempt to achieve additional goals as well. One common goal of estate

planning is tax avoidance. To understand why tax avoidance strategies are

commonly employed in estate planning you need to understand how gift

and estate taxes work first.

WHAT IS THE GIFT AND ESTATE TAX?

The gift and estate tax is a tax that is levied on your estate at the time of

your death. All gifts made during your lifetime, as well as all assets owned

by you at the time of death, are potentially subject to gift and estate taxes.

The Internal Revenue Service, or IRS, considers anything you give away

for which you do not receive full consideration in return to be a gift. In

theory, this means that a $20 birthday gift you give a friend counts;

however, because of the lifetime exemption and/or annual exclusion

(discussed later) small gifts such as this do not actually incur gift and

estate taxes. In addition, certain types of gifts, such as gifts to a political

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organization or gifts designated for the payment of medical or tuition are

excluded. The value of gifts made during your lifetime added to the value

of assets owned by you at the time of your death provides the figure on

which gift and estate taxes are calculated.

Historically, the gift and estate tax

fluctuated every few years, reaching a

rate as high as 55 percent in recent years.

Recently, however, the American

Taxpayer Relief Act of 2013, or ATRA,

permanently set the gift and estate tax

rate at a maximum of 40 percent.

Although this rate is less than what it was

just a few years ago, it still means that

you could lose a significant portion of the value of your estate to taxes

without careful planning.

THE UNLIMITED MARITAL DEDUCTION

The unlimited marital deduction

allows a taxpayer to transfer assets

of unlimited value to a spouse at the

time of death without incurring gift

and estate taxes. For illustration

purposes, imagine that Thomas and

Ellen are married at the time of

Ellen’s death on January 1st, 2014. Ellen owned assets valued at $5 million

The gift and estate tax is a tax that is levied on your estate at the time of your

death. All gifts made during your lifetime, as well as all assets owned

by you at the time of death, are potentially

subject to gift and estate taxes.

Gift and Estate Tax Basics www.nashbeanford.com 3

when she died and made a total of $2 million worth of qualifying gifts

during her lifetime. Ellen can leave all of the assets she owned at the time

of her death to Thomas without Ellen’s estate having to worry about gift

and estate taxes. Thomas’s estate, however, may pay the price (literally)

down the road. What many taxpayers fail to think about when using the

unlimited marital deduction is that it may overfund the surviving spouse’s

estate. Let’s assume that Thomas also owns assets valued at $5 million

when Ellen dies. Thomas now has an estate valued at $10 million which

would incur gift and estate taxes were Thomas to die tomorrow.

THE LIFETIME EXEMPTION

Each taxpayer is entitled to exempt a specific amount of gifts and assets

over the course of a lifetime from gift and estate taxes. Just as the tax rate

has fluctuated over the years, so has the lifetime exemption limit. ATRA

also took any future guess work out of the lifetime exemption limit by

setting it at $5 million, adjusted each year for inflation. For 2013, the limit

is $5.25 million, set to be raised to $5.34 million for 2014. Assuming that

Ellen left her $5 million estate to Thomas, he now has an estate valued at

$10 million. If Thomas were to die in 2014 his estate could exempt $5.34

million with the remainder being subject to gift and estate taxes. In other

words, Thomas’s estate would be taxed on $4.66 million ($10 million -

$5.34 million = $4.66 million). At a tax rate of 40 percent this means

Thomas’s estate would lose $1,864,000 to taxes – a significant sum for any

estate to lose.

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“PORTABILITY”

All hope is not lost, however, for Thomas’s estate thanks to the concept of

“portability” which was introduced in recent years and made permanent in

ATRA. Portability allows a married taxpayer to use any unused portion of

his or her spouse’s lifetime exemption. For Thomas and Ellen, portability

would allow Thomas to exempt another $3.34 million from his estate

before gift and estate taxes became due. Thomas cannot use Ellen’s entire

exemption because Ellen made lifetime gifts valued at $2 million, leaving

$3.34 of her lifetime exemption available to be “ported” over to Thomas.

By adding Ellen’s unused exemption amount to Thomas’s exemption we get

$8.68 million, Thomas’s total exemption amount. This brings Thomas’s

taxable estate down to just $1.32 million ($10 million -$8.68 million =

$1.32 million). That, in turn, brings the tax liability down from $1,864,000

to just $528,000, certainly a more favorable result but that still leaves

Thomas and Ellen’s loved ones short over half a million dollars.

THE ANNUAL EXCLUSION

With careful estate planning, Thomas and Ellen could have reduced their

exposure to gift and estate taxes

even more. While there are

numerous tax avoidance

strategies that can be

incorporated into an overall estate

plan, one of the simplest is

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utilizing the annual exclusion. The annual exclusion allows each taxpayer to

make gifts valued at up to $14,000 (for 2013 and thereafter) to as many

beneficiaries as the taxpayer wishes each year without incurring a gift tax.

Married couples can combine their exclusions to gift assets valued at up to

$28,000 each year. Moreover, gifts made as part of the annual exclusion

are not counted toward the lifetime exemption limit. Let’s assume that

Thomas lives another ten years after Ellen dies. Further assume that in

each of those ten years Thomas makes gifts to each of the couple’s three

children and five grandchildren valued at the yearly maximum of $14,000.

Thomas could gift $112,000 per year for a total of $1.12 million tax-free

prior to his death. Those gifts then reduce Thomas’s estate by $1.12

million as well without using any of his lifetime exemption, bringing his

taxable estate down to just $200,000 ($10 million – exemptions of $8.68

million – exclusions of $1.12 million = $200,000). Thomas’s estate now

owes just $80,000 in gift and estate taxes.

By employing gift and estate tax avoidance strategies the amount of tax

due on Thomas’s estate was reduced from $1,864,000 to $80,000, a

savings of $1,784,000 – money that will go to Thomas and Ellen’s loved

ones instead of to the IRS. Had Thomas and Ellen started earlier and

worked with an estate planning attorney there is a good likelihood that

they could have avoided a gift and estate tax obligation altogether.

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REFERENCES

Forbes, IRS Raises Limit on Tax-Free Lifetime Gifts

IRS, Frequently Asked Questions on Gift Taxes

Forbes, After the Fiscal Cliff Deal: Estate And Gift Tax Explained

IRS, What’s New—Estate and Gift Tax

Wealth Counsel, Understanding the Impact in 2012 & 2013 of Federal Estate Tax Laws

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About the Author

Robert N. Nash

Robert N. Nash is a partner in the law firm of Nash Nash Bean & Ford, LLP. The law firm has offices in Geneseo and Moline, Illinois and conference facilities available throughout Northwestern Illinois. Mr. Nash chose the estate and business planning arena because he believes it provides a positive force in his clients’ lives. He practices preventative, rather than remedial law. Robert Nash focuses on all aspects of estate planning, including estate, gift and income taxes, trust and probate administration, real estate, and business.

Nash Nash Bean & Ford, LLP www.nashbeanford.com

Geneseo 445 US Highway 6 East Geneseo, IL 61254 Phone: (309) 944-2188 Fax: (309) 944-3960

Moline 5030 38th Avenue, Suite 2 Moline, IL 61265 Phone: (309) 762-9368 Fax: (309) 944-3960

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