Many individuals assume that their estate will incur a tax upon their death. However, less than five over every 1,000 estates are subject to an estate tax. Currently, the estate tax affects only those estates worth more than $3,500,000 for decedents dying in 2009, with a marginal tax rate of 45%. This means, that for an estate of $4 million, the estate tax would be approximately $225,000. Under current law, which will likely change soon, there will be no estate tax at all for decedents dying in 2010, with a return of the estate tax for 2011 with an exemption amount of only $1 million at a marginal tax rate of 50%. While the estate tax is subject to the ebb and flow of the political climate, the consensus for the foreseeable future (8-10 years) is that the estate tax exemption amount will remain somewhere in the $3.5 million range with marginal tax rate in the range of 40-50%.
Even with the $3,500,000 estate tax exemption, spouses can leave an unlimited amount of assets to their surviving spouse. For example, an individual with even a $50 million estate can leave all of this money to a surviving spouse without an estate tax. However, upon the death of the surviving spouse, any amount over the estate tax exemption amount will be subject to the estate tax.
While most individuals do not think of themselves as being wealthy and having a taxable estate, when all assets are tallied, including life insurance, retirement plan money and real estate, the amount of the taxable estate often increases to more than one may estimate, especially after life insurance is factored. While life insurance proceeds are not subject to income tax, life insurance proceeds are generally subject to the estate tax if the decedent maintained some element of control over the policy. Ironically, many individuals with either large or illiquid estates consisting of real estate, a small business or other similar assets, purchase life insurance in an effort to provide liquidity to pay estate taxes at their death. While life insurance is a great tool to provide liquidity to pay estate taxes, unless the policy is owned and controlled by a third party, which could be an irrevocable trust, the life insurance policy actually increases the size of the taxable estate. Therefore, most estate planning advisors recommend that life insurance be held by an irrevocable life insurance trust if the possibility of an estate tax exists.
Some individuals seek to reduce their projected taxable estate by making gifts to their children, their grandchildren and even their in-laws. This can be an effective strategy, as long as all gifts are less than $12,000 per person per year (the annual gift tax exclusion) for gifts of an immediate interest. For gifts of a future interest, such as when the gift donor retains a life estate, no annual gift tax exclusion applies. When an individual makes gifts of more than $12,000 per person per year, an IRS Form 709 (Gift Tax Return) must be filed. However, as long as the lifetime gifts, reduced by the annual gift tax exclusion, are less than $1,000,000 no gift taxes are due. However, all gifts that exceed the $12,000 annual gift tax exclusion serve to reduce the estate tax exemption amount determined at death.
For estates over the exemption amount, the estate tax return is due within nine months of the date of death and the estate tax amount must be paid when the return is filed, or interest and penalties will likely accumulate.
Currently, Virginia has no separate estate or inheritance tax. However, many other states have both estate and inheritance taxes. For individuals dying a resident of Virginia, but owning real property in another state, the estate could be subjected to an estate or inheritance tax in the state in which the property is located.
For most married couples where both spouses are United States citizens, the estate tax exemption amount can be doubled with planning. The doubling of the estate tax exemption occurs by taking advantage of each spouse's unified estate tax exemption amount (currently $3.5 million). By using a credit shelter trust upon the first of the two spouses to die, a typical couple with $7 million in assets can leave their children all of their assets without incurring an estate tax. More importantly, though, upon the first spouse to die, the surviving spouse can maintain control over the entire trust and still maintain the estate tax benefits.