Comprehensive estate planning requires you to think about much more than simply who you want to receive your estate assets when you are gone. You also need to incorporate strategies that protect those assets and help them grow while you are here as well as tax avoidance strategies that limit the impact gift and estate taxes will have on your estate. One tax avoidance strategy you do not want to rely on is using the marital deduction without any additional tax avoidance tools. If you fail to plan ahead, however, the unlimited marital deduction may be the only way for your estate to avoid paying gift and estate taxes. Counting on the marital deduction alone, however, typically only serves to delay, not avoid, taxes.
Federal Gift and Estate Taxes
The federal gift and estate tax is essentially a tax on the transfer of wealth. The tax applies to transfers made during a taxpayer’s lifetime in the form of a gift as well as transfers made at the time of the taxpayer’s death. Although the federal gift and estate tax rate once fluctuated on a regular basis, the American Taxpayer Relief Act of 2012 (ATRA) permanently set the rate at 40 percent. The tax is calculated by first determining the value of all qualifying gifts made over the course of the taxpayer’s lifetime and adding that to the value of the estate let behind by the taxpayer at the time of death. For example, if you made qualifying gifts during your lifetime valued at $3 million and you died leaving behind an estate worth an addition $6 million, you would owe tax on the combined value of $9 million. Without any further deductions or adjustments, the estate would then owe 40 percent of the combined total in federal gift and estates taxes. For a moderate to large estate, this can add up to a significant amount of assets lost to Uncle Sam!
What Is the Unlimited Marital Deduction?
The unlimited marital deduction, as the name implies, allows a taxpayer to gift an unlimited amount of assets to a spouse at the time of death without incurring a tax on the transfer of those assets. In the example above, the taxpayer could leave the entire $6 million estate to his or her spouse without incurring federal gift and estate taxes on the transfer. The single biggest reason not to rely entirely on the marital deduction is that using the deduction often serves to do nothing more than delay the payment of taxes because it overfunds the recipient’s estate.
The Lifetime Exemption
The federal gift and estate tax could cause taxpayers to lose almost half of their estate’s value upon death. Fortunately, each taxpayer is entitled to a large exemption before taxes become due. Known as the “Lifetime Exemption,” it too fluctuated considerably prior to the passage of ATRA. ATRA permanently set the lifetime exemption limit at $5 million, adjusted annually for inflation. For2017, the lifetime exemption is set at $5.49 million. Therefore, only estates in which the combined value of lifetime gifts and estate assets is over the lifetime exemption amount will actually incur federal estate taxes. In the above example, the total value of lifetime gifts and assets owned at the time of death is $9 million. After deducting the lifetime exemption, the remaining $3.51 million is subject to federal gift and estate taxes at the rate of 40 percent. While that still subjects the estate to the payment of gift and estate taxes, the amount owed in taxes is significantly less.
If you are concerned about your estate’s exposure to federal and/or state estate taxes, be sure to consult with your Illinois estate planning attorney about tax avoidance tools and strategies you may be able to incorporate into your plan to help.
If you have additional questions or concerns about the marital deduction, the federal or state estate tax, or avoid tax avoidance strategies, contact the experienced Illinois estate planning attorneys at Hedeker Law, Ltd. by calling (847) 913-5415 to schedule an appointment.