An Explanation of Current Federal Estate and Gift Taxes

All taxable gifts and the estates of all decedents are taxable under a single, unified rate schedule under which lifetime taxable gifts and transfers at death are taxed on a cumulative basis. President Obama signed the American Taxpayer Relief Act of 2012 into law on January 2, 2013. Federal estate, gift and generation skipping transfer taxes were impacted as part of this legislation. Under prior law, the estate, gift and generation skipping transfer tax exemption amounts were self-adjusting and sun-setting. The new law makes the estate, gift and generation skipping transfer tax exemption and rate structure permanent. (At least until Congress changes the law.)

» Federal Estate Tax - The federal estate tax is a tax levied against all estates, and will only be payable if the taxable estate exceeds the amount of the decedent's exemption. The value of the taxable estate includes the value of all property the decedent owns at death, plus the value of all taxable gifts made by the decedent after 1976.

» Federal Gift Tax - The federal gift tax is a tax levied against lifetime gifts. Gifts in excess of $14,000 to any one person in a single year are subject to the federal gift tax.

» Generation Skipping Transfer Tax - The federal generation skipping transfer tax is a tax on transfers, either lifetime or at death, which skip a generation. For example, a gift from a grandparent to a grandchild whose parent is living skips a generation. There is a $5,000,000 generation skipping transfer tax exemption. The tax rate on transfers in excess of the exemption amount is 40%.

The generation skipping transfer exemption is not adjusted for inflation. Generation skipping transfers are included in the cumulative total of all transfers during life and at death for estate and gift tax purposes.

» Estate and Gift Tax Exemption - Commencing on January 1, 2013, the estate and gift tax exemption is an inflation-adjusted $5,000,000.00 per person. The inflation-adjusted estate and gift tax exemption for decedents dying in 2014 is $5,340,000 and in 2015 is $5,430,000.

The tax is only owed when a person's combined lifetime gifts and transfers made at death exceed the estate and gift tax exemption (expected to be $5.25 million in 2013).

» Annual Gift Tax Exclusion - In 2014, the annual gift tax exclusion is $14,000. This means each person may make gifts to third parties of $14,000 or less without using any of his or her lifetime gift and estate tax exemption. We call the $14,000 exclusion the "Christmas present exclusion". Married persons may make joint gifts to third parties, thereby being effectively taxed at lower rates and also doubling the annual exclusion to $28,000.00 per donee (recipient).

Gifts above $14,000/$28,000 per donee, do not result in the donor needing to "write a check". Rather, the donor's combined lifetime gift and estate tax exemption is used. Only after the donor's lifetime taxable gifts (and transfers at death) exceed the exemption amount is tax owed.

» Portability - Portability, the ability of a surviving spouse to use all of his or her deceased spouse's unused estate tax exemption, is permanent.

Under current IRS regulations, a surviving spouse (personal representative) is required to make an affirmative election on the deceased spouse's timely filed estate tax return to apply the deceased spouse's unused estate tax exemption to the surviving spouse's transfers during life and at death.

Although portability might appear to eliminate the need to plan, portability has limitations. The deceased spouse's unused estate tax exemption amount is not indexed for inflation; the first spouse's generation skipping transfer tax exemption is not portable; and portability is not currently available for state estate tax purposes. While portability provides a helpful safety net for married couples who have not created an estate plan while both spouses are living, for all the reasons described above, it is not a substitute for thoughtful, affirmative planning.