Basic Estate Tax Planning

How Do The Taxes On Transfers Of Wealth Work?

There is a tax imposed by the Federal Government on the transfer property to someone else, whether the transfer is made before death by gift, or upon death by will, joint ownership, or beneficiary designation. The Federal tax is called the Federal Estate and Gift Tax. This tax is a cumulative tax, i.e., each taxable transfer pushes the transferor up the tax bracket ladder. Since the top tax bracket in 2009 is 45%, proper tax planning can be crucial to preserving wealth from one generation to the next. In addition, the State of Maryland imposes an estate tax and an inheritance tax on transfers at death.

What Property Is Subject To Tax?

In general, everything you own is subject to tax, including:

One half of jointly-owned property
Face amount of life insurance policies
Value of retirement plan accounts

Can I Transfer Any Property Free From Tax?

Yes, there are three major exemptions from transfer taxes:

All transfers to a spouse are completely exempt from tax, which is known as the Marital Deduction.
Gifts by one person of up to $13,000 per year are excluded from the tax (known as the annual gift tax exclusion). If the donor’s spouse consents to the gift, this exclusion can be doubled to $26,000. (This amount is indexed for inflation.)
In addition to the Marital Deduction and annual gift exclusion, in 2009 each person has a Federal Estate Tax exemption ($3,500,000*), a Federal Gift Tax exemption ($1,000,000) and a Maryland Estate Tax Exemption ($1,000,000).

Transfers that are not exempt from tax will be subject to Federal taxes at rates ranging from a minimum of 37% to a maximum of 45%. The Maryland Estate tax rates range from a minimum of approximately 10% to a maximum of 16%.

*In 2010 the Federal Estate Tax is repealed. In 2011, it is reinstated with a $1,000,000 exemption that is indexed for inflation and a top rate of 55%.

When Should A Married Couple Worry About Transfer Taxes?

If the couple’s net worth is less than $1,000,000, they need no transfer tax planning, but should consider other estate planning to protect their assets and families. However, if their home equity, face value of life insurance, retirement accounts, and other assets total more than $1,000,000, they should take steps to minimize transfer taxes.

Should One Spouse Leave All Of His Or Her Property Directly To The Other Spouse?

Usually not if the couple is worth more than $1,000,000. Although there would be no estate taxes imposed on the death of the first spouse because of the unlimited marital deduction, on the death of the survivor, everything over $1,000,000 will be subject to tax. For example, Husband and Wife have $300,000 in home equity, $500,000 each in life insurance coverage, $600,000 in retirement plans and $100,000 in other assets (total $2,000,0000). Husband dies and leaves Wife everything, free of estate tax. Wife dies the next year, still owning the entire $2,000,000. Wife’s estate gets a $1,000,000 exemption, but the remaining $1,000,000 is taxed. The Maryland Estate Tax bill will be approximately $100,000, and the kids are left with $1,900,000. If the value of the assets were doubled ($4,000,000) the total tax bill would be approximately $1,055,000 leaving the kids with $2,945,000.

What Should Husband And Wife Have Done?

They should have split up ownership of their assets equally and set up “credit shelter” (or “bypass”) trusts in their wills. Upon Husband’s death, his $1,000,000 would go to the trust instead of to Wife outright. Wife can have all the trust income and special access to the principal during her remaining life. Husband’s $1,000,000 estate is fully covered by the Maryland $1,000,000 exemption. When Wife dies, the credit shelter trust is not counted in her estate for estate tax purposes. The $1,000,000 she does own is covered by her $1,000,000 exemption. The Maryland Estate Tax has been completely avoided, and the kids receive the entire $2,000,000. The same planning technique works to minimize the Federal Estate Tax when a couple has assets greater than $2,000,000.

Maryland Inheritance Tax: The inheritance tax is imposed on the receipt of property from a decedent. The tax rate on property received by spouse, descendants, and siblings is 0%. The tax rate on property received by “collaterals” is 10%.

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