ESTATE TAX PLANNING IN LOUISIANA

SERVING CLIENTS IN mandeville, louisiana and ALEXANDRIA, louisiana AND THE SURROUNDING AREAs

Historically speaking, the federal estate tax is an excise tax levied on the transfer of a person’s assets after death. In actuality, it is neither a death tax nor an inheritance tax, but more accurately a transfer tax. There are three distinct aspects to federal wealth transfer taxes that comprise what is called the Unified Transfer Tax: Estate Taxes, Gift Taxes, and Generation-Skipping Transfer Taxes. Legal planning to avoid or minimize these transfer taxes is both a prudent and an important aspect of comprehensive estate planning.

The most recent iteration of the federal estate, gift, and generation-skipping transfer tax was signed into law by President Trump on December 22, 2017, as part of the Tax Cuts and Jobs Act of 2017 (TCJA 2017). There are a few things you ought to know about this law which took effect on January 1, 2018. Specifically, you should know the “numbers” governing transfers subject to estate, gift, and generation-skipping transfer taxation.

FEDERAL ESTATE TAX EXEMPTION

A $5 million exemption, as indexed for inflation, was signed into law on December 17, 2010, under the Tax Relief, Unemployment Insurance Authorization, and Job Creation Act of 2010 (TRA 2010). By 2017, the federal estate tax exemption had risen to $5.49 million per individual due to the inflation feature (and a nearly “automatic”* $10.98 million for married couples who follow very specific requirements at the death of the first spouse). With the stroke of his pen on December 22, 2017, President Donald Trump increased this exemption to $11,200,000 per individual (and $22,400,000 for married couples). For 2021, that exemption is increased to an inflation-adjusted $11,700,000 per individual (and $23,400,000 for married couples). The tax rate for amounts above what can be exempted remains at 40%.

*See “Portability” below for more on this.

LIFETIME GIFT TAX EXEMPTION AND ANNUAL GIFT TAX EXCLUSION

The TCJA 2017 continues the concept of a unified exemption that ties together the gift tax and the estate tax. This means that, to the extent you utilize your lifetime gift tax exemption while living, your federal estate tax exemption at death will be reduced accordingly. Your unified lifetime gift and estate tax exemption in 2017 was $5.49 million and is now the same as the federal estate tax exemption of $11,700,000 per individual (and $23,400,000 for married couples). Likewise, the top tax rate is 40%. Note: Gifts made within your annual gift exclusion amount do not count against your unified lifetime gift and estate tax exemption.

So, how much is this annual gift exclusion?

The annual gift exclusion remains at $15,000 due to its inflation adjustment in 2018. Married couples can combine their annual gift exclusion amounts to make tax-exempt gifts totaling $30,000 to as many individuals as they choose each year, whether both spouses contribute equally, or if the entire gift comes from one spouse. In the latter instance, the couple must file an IRS Form 709 Gift Tax return and elect “gift-splitting” for the tax year in which such gift was made.  Couples can even contribute exempted gifts to a trust, as long as the trust is a properly drafted type of a trust called a “crummy trust.”

GENERATION-SKIPPING TRANSFER TAX EXEMPTION

So, what is this GSTT? Basically, it is a transfer tax on property passing from one generation to another generation that is two or more generational levels below the transferring generation. For instance, a transfer from a grandparent to a grandchild or from an individual to another unrelated individual who is more than 37.5 years younger than the transferor.

Properly done, this can transfer significant wealth between generations.

The amount that can escape federal estate taxation between generations, otherwise known as the Generation-Skipping Transfer Tax Exemption (GSTT) is unified with the federal estate tax exemption and the lifetime gift tax exemption at $11,700,000 per individual (and $23,400,000 for married couples, subject to certain specific requirements). As with estate and gift taxes, the top GSTT tax rate is 40%.

*“PORTABILITY”

The American Taxpayer Relief Act of 2012 (ATRA 2012), made “permanent” a new concept in estate planning for married couples, ostensibly rendering traditional estate tax planning unnecessary. This concept, called “portability,” means that a surviving spouse can essentially inherit the estate tax exemption of the deceased spouse without use of “A-B Trust” planning. As with most tax laws, however, the devil is in the details. For example, unless the surviving spouse files a timely (within nine months of death) Form 709 Estate Tax Return and complies with other requirements, the portability may be unavailable. However, an automatic six month extension of time to file the return is available to all estates, including those filing solely to elect portability, by filing Form 4768 on or before the due date of the estate tax return.

In addition, married couples will not be able to use the GSTT exemptions of both spouses if they elect to use “portability” as the means to secure their respective estate tax exemptions. Furthermore, reliance on “portability” in the context of blended families may result in unintentional disinheritances and other unpleasant consequences.

If you are concerned about how your current estate and gift planning may function in light of TCJA 2017, and thereafter, then we encourage you to book a call.

LOUISIANA ESTATE TAXES

Fortunately, the Louisiana inheritance and estate transfer tax system has been repealed.  However, due to state budget shortfalls, there is incessant speculation in Baton Rouge if the inheritance and estate transfer system will be reenacted.

For clients with assets (especially real estate) in other states, your assets in those states can be subject to the estate tax system of those states. 

The HIDDEN Estate Tax that Even Middle Class Clients Should be Aware Of

Often, even tax advisors don’t recognize the implications of what I call the “hidden” estate tax.  The hidden estate tax occurs when there is a failure to qualify for the Internal Revenue Code Section 1014 “step up” in basis.  The “step up” in basis is a tax provision that allows property to obtain a new tax basis for income tax purposes at an appreciated value upon death if the client holds onto the property.  However, if property is given away via a gift during life, a “step up” does not occur.  In such cases, the person who receives the gift receives it at a “transferred basis”, often meaning that it is given with a built-in gain for income tax purposes.  In other words, for clients potentially subject to the estate tax, there is almost always a trade-off between the estate tax system and the income tax system prompted by this “step up”. 

While it is almost always true that avoiding the estate tax is preferable, a qualified tax advisor should use his or her skills to ascertain at what cost the estate tax is being avoided.  It may be true that certain assets, especially assets with “built in losses” should be sold during life to create a capital loss, and other assets, especially assets with “built in gains” be retained and not given away.   Assets that are intended to stay in the family for many generations are prime candidates for gift, since in those cases the built-in gain would not matter much anyway. 

Most middle income clients do not have to worry about the estate tax.  But they should almost always be concerned about this HIDDEN estate tax.  For example, assume that you purchased real estate at $20,000 many years ago, and today it is worth $200,000.  The “built-in” gain is $180,000.  Income taxes on this built in gain could be as high as $54,000 ($180,000 X 30%, an assumed combined federal and state capital gains tax rate).  If you hold the property in such a way as to achieve the “step up”, your heirs will receive the property with a brand new basis of $200,000 on your death, resulting in no built in gains taxes.  You have just avoided the HIDDEN estate tax!  However, if you or your advisor is “penny wise but pound foolish” and attempt to forego sophisticated estate planning, and you transfer the property outright to your heirs during life, then they will receive the property with a “transferred basis” of only $20,000, thereby causing a $54,000 income tax liability to be built-in to the gift to your heirs.  This is why even for middle income clients, your estate planning attorney should also be qualified in tax law matters to ensure that you don’t incur this HIDDEN estate tax.