Estate Tax

THIS ARTICLE HAS BEEN SUPERCEDED BY:  Update on the Connecticut Estate Tax Exemption

The new Connecticut state budget, signed by Governor Malloy on October 31, 2017, increased the individual exemption for Connecticut estate and gift taxes over the next three years.  In 2017, the exemption in Connecticut was $2,000,000.  Under the new law, the exemption increased to $2,600,000 in 2018 and then to $3,600,000 in 2019.  In 2020 and beyond, the Connecticut exemption will match the federal estate and gift tax exemption.  From 2018 to 2025, the federal estate and gift tax exemption is $11,200,000. The exemption is indexed for inflation each year. A married couple with proper planning will be able to shield up to $22.4 million from federal estate tax. 

Additionally, the new Connecticut law lowers the cap on the maximum estate and gift tax payable, from $20 million to $15 million, starting in 2019.  The law also modifies the marginal rate schedule for Connecticut estates and gifts over $5.1 million, by raising the initial rate to 10%, with graduated increases of 10.4%, 10.8%, 11.2% and 11.6% for each million dollar increase, until reaching the top rate of 12% for a taxable estate or gift over $10,100,000 (see the tax rate schedule at the end of this article). 

The most important factor that no one seems to discuss is that both bills in Congress do not disturb the powerful step-up in basis at death.  To compensate for the estate tax, Congress allowed assets subject to estate tax to increase their basis to fair market value.  For example, if you bought a commercial property for $100,000 in 1980 and it rises in value to $1M at the time of your death, the basis will step up to $1M. When your children sell the commercial property after you die for $1M, they will pay no income tax because the sales price does not exceed the tax basis. By raising the exemption while retaining the step-up in basis, most people with highly appreciated assets will never pay any tax on the appreciation.   

Given the new estate tax exemptions, the Connecticut estate tax has become irrelevant for most of Connecticut’s citizens. By 2020 an individual would have to own property worth more than $11M to incur estate tax. Connecticut does not have portability but an exemption in excess of $11M will exempt most Connecticut residents from estate taxation.   

In addition to the increasing estate tax exemption, the annual exclusion amount for gifts is $15,000 in 2018, after remaining at $14,000 since 2013. As a result, starting in 2018 gifts of $15,000 or less to any number of recipients (or $30,000 or less, if made by a married couple who elect to split the gift on a properly filed gift tax return) in a calendar year will have no gift tax consequences. 

As with any change to increase estate tax exemptions, many clients will want to consider simplifying their estate plans. For instance, if your current estate plan contains special trusts to avoid estate tax, you may want to consider whether you want to use such trusts. Trusts have many useful purposes besides estate tax planning, however.  They can keep assets in the family, preserve property for children of a prior marriage, supplement public benefits, and protect assets in a divorce or a legal dispute.  If you have any questions on the current estate tax landscape and its potential effect on your estate plan, please contact the estate planning attorneys at Cipparone & Zaccaro, PC.

Happy New Year!  Some of you may wonder how much you can give this year without having to file a gift tax return and whether you need to do some estate tax planning.  Here are the key figures to keep in mind for 2015:

Estate Tax Exclusion.     This year, the federal estate tax exclusion is $5,430,000.  Thus, if an estate is worth less than that amount, no federal estate tax will be due.  The estate tax rate is 40% of the amount above estate tax exclusion.  Each spouse has his or her own estate tax exemption and can use a predeceased spouse’s unused estate tax exemption.  This principle is known as the “portability of unused exemption between spouses.”  With portability, couples can now have assets of $10,860,000 without owing any federal estate tax.  A surviving spouse who remarries will lose the prior deceased spouse’s exemption. 

The Connecticut estate tax exclusion remains at $2,000,000.  If an estate is worth less than that amount, no Connecticut estate tax will be due.  The estate tax rate ranges from 7% to 12% depending on the amount above the Connecticut estate tax exclusion.  Like the federal estate tax, each spouse has his or her own estate tax exemption.  Unlike the federal estate tax, however, there is no portability in Connecticut.  The only way for a couple to use their entire $4,000,000 estate tax exclusion is by having a credit shelter trust.

Gift Tax Exclusion.     The annual federal gift tax exclusion is $14,000 for 2015. If a person makes gifts of $14,000 each to 4 different individuals, none of the gifts are considered taxable and none of them have to be reported on Form 709, the federal gift tax return.  In 2015, a taxpayer can split gifts with his or her spouse so that $28,000 can be given to each donee.   A taxpayer, however, must report split gifts on Form 709.  The annual exclusion for gifts to non-citizen spouses is not the same as the annual exclusion for gifts to U.S. citizen spouses.  That is because gifts to non-citizen spouses can be subject to federal gift tax.  Gifts to citizen spouses are not subject to gift tax because of the unlimited gift tax marital deduction.  The annual exclusion for gifts to non-citizen spouses in 2015 is $147,000.

Besides the annual exclusion, each taxpayer also has a lifetime gift tax exclusion.  In 2014, the lifetime gift tax exclusion is $5,430,000.  By applying some of your lifetime gift tax exclusion, a gift with a value in excess of the $14,000 annual exclusion will result in no gift tax owed, but you must file a Form 709 with the IRS.  When you die, your estate tax exclusion will be reduced by the amount of the gift over the annual exclusion.  The lifetime gift tax exclusion is the same for U.S. resident non-citizens and U.S. citizens.  The federal gift tax rate is 40% for the amount above the lifetime gift tax exclusion.

In 2015, the Connecticut lifetime gift tax exclusion is $2,000,000.  Connecticut and the U.S. government have the same annual gift tax exclusion of $14,000.   You have to file a Connecticut gift tax return if you make any taxable gifts.   For example, if you are not married, and you give $50,000 to each of your 2 children, you will have to file a Connecticut gift tax return, even though no gift tax is payable.

Federal and Connecticut gift tax returns are due by April 15 of the year following the gift.

For many people, the decision to prepare a Will is easy, but the motivation to follow through is missing. The thinking goes something like this:

What’s the rush?  I am in good health.  There are more pressing matters.  I’ll get to it eventually.  I plan on being around for a long time.  Right now, I need to focus on supporting my family, saving for college and retirement, and paying for health care.  I’ll prepare a Will at the end of the year when things slow down.

The problem is most people repeat this thinking year after year… Things never seem to slow down.  Juggling time between work, family, and social events is difficult.  Who has time to plan an exit strategy?

As estate planning attorneys, we can’t imagine why people aren’t lined up at our office door every morning like Apple customers waiting for the release of the next iPhone.  Death and taxes – everyone’s favorite topics, right?

All kidding aside, preparing a Will is very important for the future of your family.  If you unexpectedly pass away, your family must deal with the great emotional void created by your absence.  They also must find a way to manage without your financial support.  One can ease this burden by proper planning.  So, why doesn’t everyone prepare an estate plan?

Recent surveys find that only about 50% of American adults have prepared a Will.  According to one Gallup Poll, 71% of respondents aged 50 and older had a Will. That percentage fell to 37% for people under 50.

Why don’t people prepare an estate plan?  Many people just haven’t gotten around to it.  Others don’t believe they own enough assets to worry about estate planning.  Still others believe that state laws mirror the wishes they would express in a Will or Trust.  Are they right?  Let’s take a look.

If you die without a Will in Connecticut, the laws of intestacy become your estate plan and determine who gets your probate property.  If you think you don’t have a Will, think again.  Did you know state law requires if you don’t have a Will and  you are survived by children, your spouse gets the first one hundred thousand dollars, plus one-half of the balance of your estate, and the remainder is divided among your children (regardless of their age)?  If any of your children are from a prior marriage, your spouse only gets one-half of your estate and the remainder is divided among your children.  If you are married but have no children, the first $100,000 goes to your spouse, but after that your spouse gets 3/4 of the remainder and your parent(s) gets the remaining 1/4 . You would be hard pressed to find anyone who has prepared a Will intentionally dividing their assets in that manner, but that is what would happen without a Will. A Will ensures your property goes to the people you choose as you desire, not according to state law.

So, all I need is a simple will, right?  No!  A proper estate plan should address more than just the final distribution of your property.  What about the important question of who will care for  your kids if you die?  Certainly, if you have children under 18, you owe it to them to choose a proper Guardian to take care of them. If you do not make a written nomination of guardians for your children, a judge will choose the guardians.  Do you really want a judge to make that choice without your input?

A comprehensive plan should also cover the potential for physical or mental incapacity.  Who will manage your assets if you become incapable?  Who will make your healthcare decisions if you are unable?  To address these concerns, your plan should include a Durable Power of Attorney to designate a person to manage your assets and an Appointment of Health Care Representative to designate a person to manage your health care.

What about your cherished pet?  Will someone take care of Fluffy or will she spend her final days in an animal shelter waiting to be euthanized?  A thorough estate plan will also cover the care of your pets when you are gone.

You should also consider the benefits of a trust.  If you have children who haven’t reached 22, or adult children who are either disabled, owe a lot of debt, or are in the middle of divorce, including a trust in your estate plan gives you an opportunity to choose a person who will manage your child’s funds and assure the funds are not squandered or distributed outside the family to creditors or an ex-spouse.  You can name a trusted friend, family member or professional to serve as trustee and oversee the trust investments and distributions.  You can also avoid the need to probate the assets held in the trust at your death, which is desirable for out-of-state real estate.

Most conversations about estate planning begin with a client’s desire for a “simple Will.”  However, a will is only one of many important documents that should be part of every estate plan.  A proper estate plan addresses all of these issues and often more.  Will 2014 be the year you finally prepare a thoughtful estate plan?

For many people, the new $5.34 million applicable exclusion amount is more than adequate to avoid the federal estate tax. But, if you transfer more than $5.34 million upon your death, you will be taxed at the estate tax rate of 40 percent. 

Moreover, the new federal estate tax exemption does not apply to state estate taxes.  Many states, including Connecticut, impose a separate estate tax.  The Connecticut applicable exclusion amount is only $2 million. Thus, if a taxable estate exceeds $2 million, a Connecticut estate tax will be due. The Connecticut estate tax rate ranges from 7% to 12% depending on the amount above the Connecticut estate tax exclusion.  So for example, a $2.5 million taxable estate would owe approximately $36,000 in Connecticut estate taxes (this is a simplified calculation not accounting for administration expenses and assuming no lifetime taxable gifts).

Due to the low state exemption amount, many Connecticut residents should take steps to avoid estate taxes.  The following is a brief overview of two trusts that can help you avoid estate taxes.

Irrevocable Life Insurance Trusts (ILIT)

Did you know that the value of the death benefit of your life insurance policy will be included in your taxable estate even though your policy pays directly to beneficiaries and bypasses your probate estate?  For example, a $1 million life insurance policy made payable to your spouse still becomes part of your taxable estate.  A large policy like this could easily push many estates into the taxable bracket. 

The good news is you can exclude the entire amount of your life insurance policy by transferring ownership to an Irrevocable Life Insurance Trust (“ILIT”) or buying a new policy in the name of an ILIT.  You will need to name the ILIT as the owner and beneficiary of the life insurance, but you can name your spouse as a lifetime beneficiary of the Trust with a remainder to your children or grandchildren. You can use an ILIT to establish an education fund for your children or grandchildren, or to fund the buy-out of a business.  Each premium payment is a gift for gift tax purposes so a gift tax return may be due if the premium exceeds the $14,000 per person annual gift tax exclusion or if beneficiaries do not have the right to withdraw any trust contributions used to pay the premiums. An ILIT can be an effective tool for transferring wealth to your spouse or your descendants tax free. 

Credit Shelter Trust to combine exemptions of married couple

Another tax saving trust is commonly referred to as the Credit Shelter Trust.  Each spouse has his or her own estate tax exemption or credit.  By combining their exemptions, spouses can shelter a combined $10.68 million for federal and $4 million for Connecticut purposes. Spouses also have the benefit of the unlimited marital deduction.  The marital deduction allows the tax free transfer of assets of any amount between spouses.  By combining both spouses’ estate tax exemptions with the use of the marital deduction, a couple can avoid estate taxation upon the death of the first spouse and shelter up to the full amount of both exemptions upon the death of the surviving spouse.

The new federal law makes the estate tax exemption "portable" between spouses. This means that if the first spouse to die does not use all of his or her $5.34 million exemption, the estate of the surviving spouse may use it. For example, John dies in 2014 leaving an estate of $3 million to his wife Mary. He has no taxable estate because of the unlimited marital deduction.  His wife, Mary, can then pass on up to $10.68 million (her own $5.34 million exclusion plus her husband's unused $5.34 million exclusion) free of federal tax.  Mary must make an "election" on John's estate tax return to take advantage of portability and preserve John’s unused exclusion.

Unlike the federal law, however, Connecticut law does not provide for portability of the estate tax exemption. The only way for a Connecticut couple to ensure the use of their entire combined $4 million estate tax exclusion is by using a Credit Shelter Trust. 

A Credit Shelter Trust is designed to hold up to your remaining applicable exclusion amount.  So, for example, John dies in 2014 and passes on $3 million to his wife Mary. Without a credit shelter trust, the entire $3 million could pass to Mary because of the marital deduction.  However, John’s unused Connecticut exemption would be lost.  If Mary died later that year, she would only have her own $2 million Connecticut exemption available to cover her $3 million estate.  One million of her estate would be subject to estate taxation and Mary’s estate would owe approximately $72,000 in Connecticut estate taxes (this is a simplified calculation not accounting for administration expenses and assuming no lifetime taxable gifts). 

Alternatively, John could fund a Credit Shelter Trust with $2million upon his death.  This amount would be sheltered by his available $2 million exclusion amount.  The remaining $1million could pass to Mary using the marital deduction.  Upon Mary’s later death, she would only have $1 million in her estate, which she could cover with her $2 million exclusion.  The balance of John’s Credit Shelter Trust will pass outside of her estate to their children without being reduced by estate taxes even if it grew beyond $2 million.