Should you become incapacitated or when your time comes, estate planning serves to manage and protect your assets. Tasks that are generally included in estate planning are the creation of a will, establishing a guardian for living dependents, the naming of an executor, setting up a durable power of attorney (POA), designating beneficiaries for plans such as IRAs and life insurance, and limiting estate taxes.
TUTORIAL: Estate Planning
Estate planning is a dynamic and ongoing process, and as estate law changes, you'll need to respond appropriately. On December 17, 2010, President Obama signed into law the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act ("TRUIRJCA" or "TRA 2010" for short). This new law provides changes to rules that govern federal estate taxes, gift taxes and generation-skipping transfer taxes for the 2010, 2011 and 2012 tax years.
What is the Federal Estate Tax?
A federal estate tax is collected when a person's assets are transferred to an heir or heirs if the value of the estate exceeds a certain amount. The tax is based on the sum of the fair market values of the decedent's assets on the date of death, less any estate tax credits and allowable deductions. Assets that are transferred to a surviving spouse are not taxed due to the unlimited marital deduction. (For related reading, see Get Ready For The Estate Tax Phase-Out.)
What is a Generation Skipping Transfer Tax?
A tax that is assessed on property that is transferred from one generation to a generation that is two or more levels below the transferor's generation is known as a generation skipping transfer tax. A property that is transferred from a grandparent to a living grandchild, for example, would be exposed to the generation skipping transfer tax, subject to the current exemption amounts. (For more see, A Look At The Generation-Skipping Transfer Tax.)
What is a Gift Tax?
A gift tax is assessed on the value of property (such as stocks or cash) that one person provides to another as a gift. The individual who makes the gift is responsible reporting the gift to the IRS and for paying the federal gift tax. The individual receiving the gift does not need to report the gift to the IRS as part of his or her income. In 2010 and 2011, the annual exclusion from gift tax is $13,000, meaning that an individual can gift up to $13,000 to as many people as he or she likes (children and grandchildren, for example) without triggering the gift tax. Spouses may together gift up to $26,000 per year to any number of individuals without triggering the tax. The gift tax is due only when the entire lifetime gift amount to non-spouse heirs ($5 million starting in 2011) has been surpassed.
What Changes Did TRA 2010 Effect?
New and Unified Exemptions and Tax Rates
For 2011 and 2012, the federal estate tax exemption will be $5 million. The estate tax rate will be 35% for estate values greater than $5 million. In addition, federal gift tax and generation-skipping transfer tax exemptions will each be $5 million with a tax rate of 35%. For deaths that occur during 2010, the decedent's heirs can choose to apply the 2011 federal estate tax or the 2010 unlimited exemption. For most families, the 2011 rules will provide a more favorable outcome since the exemption is so large that very few estates would owe any tax.
Portability between Married Couples
The new law allows for portability of the federal estate tax exemption between married couples for deaths that occur during the 2011 and 2012 tax years. Any unused portion of the estate tax exemption from a deceased spouse can be passed to the surviving spouse, effectively permitting married couples to pass up to $10 million to their heirs without incurring estate taxes.
The Bottom Line
Many states collect estate taxes and/or inheritance taxes in addition to the federal estate taxes. Estate tax laws are complicated and may change, and since significant money may be at stake, a qualified tax specialist should be consulted before making any decisions and after any laws have changed. After December 31, 2012, estate tax laws are expected to revert to the laws that were in effect in 2001/2002 with the federal estate tax exemption dropping to $1 million and the estate tax rate climbing to 55%. (For further reading, see Refusing An Inheritance.)