There’s plenty of talk about estate taxes these days. While your estate is directly liable for paying any estate taxes when you die, all recipients of assets have a responsibility to ensure that taxes are paid on the assets that they receive, so the heirs are usually burdened by the estate tax. However, with proper planning, the estate tax liability can be greatly reduced or possibly eliminated, says David Neal, the tax director at Whitley Penn LLP, CPAs & Professional Consultants.
“In order to reduce your estate tax liability, it’s critical to work with an adviser with experience in gift giving and estate planning,” he says.
Smart Business spoke with Neal about the estate tax, how it’s calculated and ways to mitigate the estate tax liability.
What is the estate tax?
The estate tax is the tax on the actual transfer of assets from the decedent to another party.
Basically, an estate tax is determined by calculating all of the property that the decedent had ownership, control or the complete use of. The most commonly overlooked asset is life insurance. This is particularly true for younger people who don’t think they have an estate large enough to qualify for the estate tax, yet they have a large life insurance policy. If something happens, it becomes a taxable estate.
The estate tax is based on a snapshot on the date of death, or you can use an alternative date of six months past the date of death, whichever date is in your favor.
For example, if a person died Sept. 1 owning a valuable piece of property in New Orleans that was hit by a hurricane on Nov. 1, the value of the property would be determined on Sept. 1 — the day the person died. In that case, you’d want to take the alternative six months later due to the decrease in the asset value. By the same token, if the person owned stock that was worth a certain value at the date of death but was worth twice as much five days later, you’d want to use the value of the stock at the date of the death so those profits would be excluded from the estate.
How can one reduce exposure to the estate tax?
There are exemptions to mitigate the tax liability. Every person is granted a lifetime exemption that currently stands at $2 million. Proper planning can help ensure that the exemption is fully utilized.
For example, in the case of a married couple in which one spouse had $3 million in assets and the other spouse had none, if the spouse that had no assets dies first, there will be no utilization of that person’s lifetime credit. When the second spouse dies, that person would have $1 million more than the exemption and the estate would have to pay $450,000 in estate taxes. With proper planning, perhaps utilizing a trust, this couple could have reduced its exposure to the estate tax. Not taking full advantage of both spouses’ exemptions is probably the most common estate planning mistake.
There are other deductions such as the administration expenses of the estate, including the funeral expenses.
There’s also what I call ‘winning by attrition,’ which allows individuals to give $12,000 annually per person to their heirs. There are some rules governing these gifts, but this allows individuals to significantly pare down their estate in an effort to reduce their estate tax liability.
Lastly, individuals with large qualified plans and IRAs should be sure to consult with an experienced tax adviser, as these can be particularly tricky in estate planning.
How can someone determine whether or not they will owe an estate tax?
Basically, you just need to add up everything you own and subtract everything that you owe. But keep in mind a few things that are often forgotten like the face value of any life insurance and the full value of assets. You need to look at the fair market value of the assets and determine by what a willing buyer and a willing seller would agree to as a sales price.
Isn’t there talk that Congress is going to repeal the estate tax?
Currently, the estate tax exemption is set to increase in 2008 and 2009. The tax is due to disappear in 2010, but I believe it’s highly unlikely that Congress will allow that to happen. Most commentators believe the exemption will rise to $5 million, coupled with a reduction in the tax rate.
DAVID NEAL is the tax director at Whitley Penn LLP, CPAs & Professional Consultants. Reach him at (817) 258-9100 or [email protected].
