Basics Aspects of the Federal Transfer Tax in Florida (cont)
On Monday, I wrote about the federal gift tax as part of the federal transfer tax system. Again, anytime you give anything to anyone, whether during life or death, the federal government wants you to pay a tax on that transfer unless you fall within one of their exemptions.
The second transfer tax is the federal estate tax. The current federal estate tax exemption is $5.120 million dollars (up from $5 million in 2011 due to inflation). That means every U.S. citizen has $5.120 million dollars they may leave completely tax free upon their death. Any amounts above the $5.120 million are taxed at a 35% tax rate.
There are two important points to the estate tax however. First, remember in my last blog that I said that everyone has $5.120 million that they may transfer during their lifetime, either all at once or in small amounts over time. Every dollar you use of the $5.120 million during your lifetime, you also lower the amount you can pass upon your death. So if Bob gives a $1 million gift to his daughter during his life, Bob will file a gift tax return for the gift and will only have $4.120 million he may leave upon his death.
I counsel clients all the time though that it is cheaper to give during your life than it is upon your death. The reason is that if you owe a gift tax, you will be paying the tax with money outside of the gift. If you have to pay an estate tax, then you will pay the tax with money that is includible in your estate – paying the tax with money being taxed. So if you can lower your estate while you are alive, it will cost you less in taxes in the end.
The second important point is that that there is currently the concept of portability in the estate tax. What is portability you may ask? It is the concept that if you are married and do not fully use your $5.120 million exemption upon your death, that any unused amount will pass to your surviving spouse for them to use upon their death. For example, if Bob dies with a $2 million estate, his wife, Susan, will have an additional $3.120 million to use upon her death. So she will have $8.240 million she may leave tax-free upon her death.
To be able to use your deceased spouse’s unused estate tax credit, you must file an estate tax return for their estate. The estate tax return is due 9 months from the date of death. Further, portability of the estate tax is set to expire at the end of 2012 along with the $5.120 million exemption per person. Without Congressional action, the estate tax exemption will revert back to $1 million per person with every dollar thereafter being taxed at 55%.
The last federal transfer tax is what is called the generation-skipping tax. The best way to explain this tax is with an example. Assume Bob has grandchildren and he wishes to leave them $10.120 million. As explained above, he has $5.120 he can leave tax free in 2012 so we would take $5.120 off of the $10.120 million for an amount of $5 million, which is subject to the estate tax. However, since Bob is skipping a generation, his children, he must also pay the generation-skipping tax, which is currently 35%. So he would pay a total tax of between 60% - 70% for the transfer to his grandchildren.
The rationale from the IRS for this tax is that usually you would pay an estate tax for the amount you pass to your children and then your children would pay an estate tax when they pass assets to their children (Bob’s grandchildren). Since you are skipping the middle tax, the IRS takes it now. Think of this tax as a mousetrap, easy to avoid but if you get caught
To learn more about the federal transfer tax and how to avoid it, please consult our estate planning attorney at Wood, Atter & Wolf, P.A. in Jacksonville and Ponte Vedra Beach, Florida.
