What is a Disclaimer Trust?

A Disclaimer Trust is a special type of trust often created under a Will (or as a sub-trust of a revocable living trust) that generally allows a person to refuse an asset and still benefit from it under a trust.  In order to understand Disclaimer Trusts, you first need to understand what a disclaimer is and what happens when you make a disclaimer so that you can understand the purpose and mechanics of Disclaimer Trusts.

What is a Disclaimer?

A disclaimer is literally when someone refuses to accept money or an inheritance.  A person can disclaim a gift, an inheritance, an interest in a trust, or certain powers.  (Let's call this the "Disclaimed Interest".) A person can also make a partial disclaimer, such as disclaiming half of their inheritance (although special rules apply to this).

What Happens When a Disclaimer Is Made?

When a Disclaimer is done correctly, it has the affect of treating the person who disclaims as if he or she died prior to the Disclaimed Interest being made.  So, if a Wife is disclaiming an inheritance from her Husband, it treats the Wife as if she had died before the Husband for whatever amount Wife disclaims.  Generally, in order for a disclaimer to be effective for tax purposes, it must be done within nine months from the date of death AND the beneficiary cannot have accepted the Disclaimed Interest.

Since the Disclaiming party is treated as if he or she died before the gift or bequest was made, the Disclaimed Interest will pass to the next person in line who is suppose to receive that.  For example, if a Will says, everything to my spouse, and upon the death of my spouse, it all goes to my children, then if the surviving spouse disclaims her inheritance, it would all go to the children.  However, that may not be the result the surviving spouse wants.  She might want to have access to that money during her lifetime and only have it go to the children upon her death.

What is the Purpose of a Disclaimer Trust?

The purpose of a Disclaimer Trust is that it allows a surviving spouse to inherit money, but to do so in a way that would be more tax efficient for the descendants of the person creating the Will.

This tax efficiency is probably best illustrated by two examples of how it affected NJ residents prior to 2017.  Back when NJ had a state estate tax, it often wasn't beneficial for the surviving spouse to inherit everything outright. New Jersey had a 'use it or lose it' state estate tax exemption of $675,000.  So, if a married couple owned $1,350,000 of assets, and when one spouse dies they wish everything to go for the benefit of the survivor and then down to the children:

1. Example 1 - Upon the first to die, everything goes to surviving spouse outright.  When the second spouse dies, she would only have one NJ estate tax exemption of $675,000.  So assuming no growth in assets, the remaining $675,000 would have been subject to the NJ estate tax, resulting in a tax of almost $55,000.
2. Example 2 - Upon the first to die, everything goes into trust for the surviving spouse.  This utilized the estate tax exemption of the first person to die.  The surviving spouse still had access to the funds in trust, but when she died and everything went to the children, there was no NJ estate tax because she also had an estate tax exemption.

Under What Circumstances Should a Surviving Spouse Disclaim Assets into a Disclaimer Trust?

A surviving spouse should disclaim an inheritance into a Disclaimer Trust when it would be tax efficient to do so.  If we go back to our example above, let's say the couple with $1,350,000 has their estate dwindle down to $500,000, or they move to another estate without a state estate tax, or the estate tax exemption has increased well beyond what they expect to have when the surviving spouse dies, there would be no point in the surviving spouse disclaiming. 

If it is highly like that the surviving spouse will live in a state that has a state estate tax, and it the surviving spouses assets (including the inheritance) would be above that state's estate tax thresh-hold, then it often beneficial for the surviving spouse to disclaim the assets into a Disclaimer Trust.

(Incidentally, before the federal government had portability between spouses of the federal estate tax exemption, this was a part of practically every single Will for married couples.  Since portability and the increase the federal estate tax thresh-holds, fewer attorneys are including these clauses unless the state has an estate tax.)

When Should a Surviving Spouse Disclaim Assets into a Disclaimer Trust?

For a disclaimer to be effective for tax purposes, it must be done within nine months from the date of death.  The nice thing about Disclaimer Trust planning for couples is that it allows the surviving spouse to take a look at all the facts and circumstances when the first spouse dies.  

It is important to remember that the funding of a Disclaimer Trust is always optional.  A disclaimer Trust will NOT get funded unless the surviving spouse makes files a qualified disclaimer according to local state rules.  You can analyze your wealth situation, need for cash, look at the tax laws and figure out what is best for your situation.

What are the Tax Consequences of a Disclaimer?

If a Surviving Spouse disclaims within the nine period and does so according the rules set out by the IRS (basically not taking the property first, not directing where the disclaimed property goes, and complying with state rules on disclaimers), then the disclaimed amount will be includible in the decedent's taxable estate.  This is generally what you want as you are disclaiming to utilize the decedent's estate tax exemption amount.

The person disclaiming must be careful not to disclaim too much, otherwise that might trigger an estate tax on the first to die.

It should be noted that failing to disclaim in a timely fashion or in a way proscribed by the IRS will result in the disclaimer be treated as a taxable gift by the Disclaimant.  Basically, it's as if the surviving spouse accepted the property and then gifted it away.

Alternatives to a Disclaimer Trust Plan

The question I always ask my clients is whether or not they want to guarantee that money go into trust for the surviving spouse.  If they want to guarantee the use of an estate tax exemption or if they want to protect the money from a future spouse, we wouldn't do a Disclaimer Trust plan, we would just automatically fund a trust for the benefit of the surviving spouse upon the death of the first spouse instead of giving the surviving spouse the option to fund it upon the first to die.

However, many people aren't concerned about the surviving spouse remarrying, and they want to keep things simple.  Usually in those cases, we would allow the surviving spouse to disclaim their inheritance into a Disclaimer Trust upon the first to die if there is a tax reason to do so.

If the surviving spouse really doesn't need the money, he or she can also take the money and gift it to the children (or wherever you wish). Remember, this can result in a taxable gift.  However, with the high estate and gift tax exemption limits ($11.2M per person in 2018), most people will not actually incur a gift tax unless you make a very large gift.

Who Can Make a Disclaimer?

Throughout this post I have talked about the ability of a Surviving Spouse to make a disclaimer, and while anyone can disclaim an asset, only a Surviving Spouse can disclaim an asset in to a trust for the benefit of himself or herself.  The general rule for anyone other than a surviving spouse is that you cannot disclaim money and still benefit from it.  Accordingly, your child can never disclaim into a trust for his or her benefit.  

On the other hand, attorneys frequently create estate plans that give money to child, but if child dies, her share goes to grandchild in trust.  If the child is wealthy, she might not want or need the money and then Child can disclaim funds into grandchild's trust and act as trustee of that trust.

Problems With Disclaimer Trust Planning

The biggest problem with Disclaimer Trust planning is that the surviving spouse often fails to make an effective disclaimer.  If the surviving spouse doesn't seek counsel within nine months of the first spouse's date of death, or they transfer money into their own name, then an effective disclaimer cannot be made.

Balancing Estate Tax Planning and Capital Gains Tax Planning

One of the trickiest aspects of deciding whether or not to do a disclaimer is calculating whether a disclaimer will minimize overall taxes and expenses.  If the assets are in the surviving spouse's name, it can be subject to extra estate taxes.  If the assets are titled in the name of a Disclaimer Trust, it could produce additional capital gains taxes, accounting fees and other costs.  I would strongly urge you to consult with a tax attorney before exercising a disclaimer.

How Do I Know if My Estate Plan Includes a Disclaimer Trust?

The Will or Revocable Trust usually says something to the effect of "I leave everything to my spouse, but if my spouse disclaims all or a part of his or her inheritance, such disclaimed portion will be distributed pursuant to the Disclaimer Trust created hereunder."

A surviving spouse should be careful of disclaiming if no Disclaimer Trust is established under the Will or Revocable Living Trust as a disclaimer could have the effect of sending everything to the children.

If a Disclaimer Trust is Primarily for Married Couples Living in a State That Has a State Estate Tax, Why Do My Documents Have a Disclaimer Trust?

Disclaimer Trust planning is most useful in states still have a state estate tax.  However, many attorneys will automatically put it in the estate planning documents for a married couple even if they live in a state that doesn't have a state estate tax just in case the client moves to a jurisdiction that does have the tax.  Moreover, it was common practice to do Disclaimer Trust planning prior to 2001 when the federal government allowed spouses to port their unused federal estate tax exemption to the surviving spouse.  Accordingly, there is a historical component to this in all states.

Is there Any Harm to Having a Disclaimer Trust in my Will or Revocable Trust Even Though I Know I Will Never Use It?

Attorneys never like to use the word "never".  So, I will say that it would be very surprising if there is any harm in having a Disclaimer Trust in your Will or other estate planning documents.  It is a great failsafe.

Change to Estate Tax Exemption Limit for 2018

While the House and Senate are considering competing tax proposals, including a proposal to eliminate the federal estate tax, it is worth noting that the IRS has release Revenue Procedure 2017-58 which provides inflationary updates for a number of provisions in the Internal Revenue Code.

Assuming that the Republicans do not pass a bill that modifies the existing estate tax and gift tax structure, for 2018:

1. US Citizens and Permanent Residence Aliens can pass on $5,600,000 per person upon death or during their lifetime.  The federal estate tax exemption is also known by several other terms including the lifetime gift exemption, the basic exclusion amount, and the unified applicable exclusion amount.   The exemption is being increased by $110,000 from its 2017 limit of $5,490,000;
2. The annual gift tax exclusion will increase to $15,000 per person, per donee.  This is up from $14,000 in 2017; and
3. The annual exclusion for gifts made to a non U.S. Citizen spouse has been increased to $152,000.  This is up from $149,000 in 2017.

This revenue procedure does not change any laws.  It is simply designed to inform taxpayers of any changes in tax provisions as a result of inflation. 

Japanese Inheritance Tax vs. US Estate Tax (2014 Update)

BRIEF OVERVIEW OF
JAPANESE INHERITANCE AND GIFT TAXES
vs.
AMERICAN ESTATE AND GIFT TAXES

(2014 Update)

I. Estate Taxes

A. America

1. If the Decedent is a Citizen or Permanent Resident

a. Tax on Worldwide property (credit for taxes paid to foreign countries)

b. Exemption of $5,340,000 in 2014 (indexed for inflation). For married couples, the exemption amount is $10,680,000 as a result of portability.

c. Federal Estate Tax of 40% on amount over $5,340,000

d. Unlimited Marital Deduction for Surviving Spouse if Surviving Spouse is a citizen

2. If the Decedent is a Non-Citizen/Non-Permanent Resident

a. Tax only on Real Property and business interests in the United States (Cash in foreign banks and foreign stocks are not taxed)

b. Exemption of $60,000 for US based Assets

c. Tax of between 18%-40% on amount over $60,000

d. Unlimited Marital deduction if Surviving Spouse a citizen
e. Tax on bequest to surviving spouse can be delayed by creating a Qualified Domestic Trust

3. If the Decedent is not a United States Citizen or permanent resident alien, assets outside of the US can pass to a US person with no US estate tax.

B. Japan (Actually an Inheritance tax, not an estate tax)

1. Japanese Citizens and Permanent Residents

a. Tax on Worldwide property (credit for taxes paid to foreign countries) - [NOTE - this is new for 2013, previously Japan did not tax worldwide assets] 
b.  Exemption of ¥30,000,000 + (¥6,000,000 for each statutory heir); Possible additional exemption for insurance money, retirement savings, and money left to handicapped individuals [NOTE - this is a reduction from the previous exemption of ¥50,000,000 and ¥10,000,000 per statutory heir.]

c. Additional exemption for life insurance received of ¥5,000,000 multiplied by the number of statutory heirs

c. Until December 31, the highest tax rate is 50%.  Effective January 1, 2015, tax between 10%-55% for statutory heirs (spouse, children and parents) after you go over the exemption amount;

• Up to ¥10 million 10%
• Above ¥10 million up to ¥30 million 15%
• Above ¥30 million up to ¥50 million 20%
• Above ¥50 million up to ¥100 million 30%
• Above ¥100 million up to ¥200 million 40%
• Above ¥200 million up to ¥300 million 45%
• Above ¥300 million up to ¥600 million 50%
• Over ¥600 million 55% 

d. An additional 20% surcharge for everyone other else other than charities (this does include a surcharge on gifts to grandchildren);

e. For property outside of Japan, a beneficiary that acquires property will be subject to Japanese inheritance tax. (THIS IS A MAJOR CHANGE, prior to April 1, 2013, Japan did not tax gifts or inheritance of property outside of Japan received by non-Japanese nationals.)

f. A surviving spouse is entitled to a tax deduction. This is a complex formula based upon who is living at the time of the Decedent's death and where the money goes. Generally, a surviving spouse can deduct about 1/2 to 2/3 of the tax.

2. Non-Citizens/Non-Permanent Residents

a. If beneficiary is not Japanese and not living in Japan and property is not in Japan, appears Country where property located will tax such property.
b. I'm currently double checking to see if the Beneficiary is a Japanese Domiciliary whether Japan CAN tax inheritance regardless of where Decedent lived and regardless of where assets are located (subject to tax treaties)

c. If there is a tax, it appears a surviving spouse is entitled to the same marital tax deduction as for Japanese citizens.

3. Real estate acquisition tax is exempt if passing by bequest.  There is a registration and license tax at the rate of 0.4% of the assessed value of the land and building. (currently reduced?)

II. Gift Taxes

A. America

1. Citizens and Permanent Residents

a. Tax on all gift transfers of Worldwide property

b. Annual exemption of $14,000 per person/per donee (unlimited gifts for donees if different donors)

c. An annual gift to a non-citizen, permanent resident spouse, of $145,000 is available.

d. Lifetime exemption of $5,340,000

e. Gifts may be split with spouse

f. Tax rate of 40% if lifetime gifts exceed $5,340,000

2. Non-Citizens/Non-Permanent Residents

a. Tax on all gift transfers of US Property (including real estate and Stocks in US companies)

b. Annual exemption of $14,000 per person/per donee (unlimited gifts for donees if different donors)

c. Annual gift tax exemption if gift to a spouse of $145,000 (Note that a person can gift more to a spouse than they can bequest to a spouse)

c. No Lifetime exemption

d. Gifts may not be split with spouse

e. Tax rate of 18%-40% if gifts exceed $14,000

B. Japan (Rates between 10%-55%)

1. Citizens and Permanent Residents of Japan

a. Tax on gifts of property Worldwide (credit for taxes paid to foreign countries) - [NOTE - this is new for 2013, previously Japan did not tax gifts worldwide assets to certain people] 

a. Annual exemption of ¥1,100,000 for each beneficiary (beneficiary taxed after this)

b. One time spouse exemption of ¥20,000,000

c. Effective January 1, 2015, tax between 10%-55% for statutory heirs (spouse, children and parents) after you go over the exemption amount;

• Up to ¥2 million 10%
• Above ¥2 million up to ¥4 million 15%
• Above ¥4 million up to ¥6 million 20%
• Above ¥6 million up to ¥10 million 30%
• Above ¥10 million up to ¥15 million 40%
• Above ¥15 million up to ¥30 million 45%
• Above ¥30 million up to ¥45 million 50%
• Over ¥45 million 55% 
• The threshold is lower for gifts to other individuals.

d. For property outside of Japan, a donee that acquires property will be subject to Japanese gift tax.  (THIS IS A MAJOR CHANGE, prior to April 1, 2013, Japan did not tax gifts or inheritance of property outside of Japan received by non-Japanese national.)

2. Non-Citizens/Non-Permanent Residents

a. Annual exemption of ¥1,100,000 for each beneficiary(unclear – enforcement is almost impossible)
b. Japan will tax donees who live in Japan.

3. Special real estate acquisition tax of 4% (currently reduced?) in addition to a registration and license tax at the rate of 2% of the assessed value of the land and building.

III. Generation Skipping Taxes (Taxes on gifts or bequests to grandchildren or lower generations)

A. America

1. Exemption of $5,340,000 (indexed for inflation)
2. Tax of 40% on rest

B. Japan

1. None

Remember, there is an estate and inheritance treaty between the United States and Japan to minimize double taxation of assets on death if you own assets in both countries or are a resident of one living in the other country

For more information on Japanese taxes, the Japanese government has a website in English with some helpful facts, but it is now very outdated. 

I am not licensed to practice in Japan, this is just my understanding of Japanese gift and inheritance tax law that I can gather from sources which are written in English.

NOTE- Major rewrite on 9/12/14 to address changes in rates and fact that assets outside of Japan are now subject to Japanese inheritance and gift tax.

Gifting to Parents to Save on Capital Gains Taxes

As I gaze outside at yet another major snowstorm here in Mercer County, NJ and contemplate how nice it would be if I were visiting my folks near my Boca Raton, Florida office, I am reminded of a tax savings idea that I heard was gaining traction amongst wealthy children whose parents are still living.

With the federal estate tax exemption up to $5,340,000 after its most recent adjustment for inflation, children that own highly appreciated assets (such as stock or real estate) can simply gift these assets to their parents now. When the parent passes away, the children can receive these assets back with a stepped up basis, potentially saving hundred of thousands of dollars in capital gains taxes when the assets are finally sold.

While at first blush this seems like an incredibly easy strategy to save money on taxes, there are actually many pitfalls. In particular, the strategy will not work well if:
1) the parent is receiving Medicaid or government benefits;
2) the parent lives in a state or jurisdiction that has a state estate tax or inheritance tax;
3) the parent has remarried; 
4) the parent has significant wealth and has their own estate tax problems; or
5) MOST IMPORTANTLY, the gift must be made to the parents at least one year prior to the parent's death to avoid triggering Section 1014(e) of the Internal Revenue Code.*

Additionally, there could be problems if you have siblings or step siblings as the child who originally owned the assets would obviously want to ensure their return. Here is the final catch, the IRS will not like it if you prearrange this plan. In other words, the parent can't immediately promise/guarantee that they will redirect the asset to the child.

Finally, gifts of certain assets will require an appraisal for the federal gift tax return that would be required (Form 709), potentially making this a costly transaction.

Please contact our attorneys if you would like to learn more about this type of gift planning or any other estate planning.

*Updated on 5/22/14 to reflect the need to make the gift at least one year prior to parent's death.

Making a Year End Gift Before Going Over the Fiscal Cliff

Just a reminder, for the rest of this year, every US citizen and permanent resident alien has a $5,120,000 gift tax exemption.  On January 1, 2013, regardless of who the president is, if Congress does nothing, then the gift tax exemption drops down to about $1,000,000.  (Technically I think it is $1,000,000 indexed for inflation back to 2001.) 

So, if you are in the fortunate position of having extra money that you do not need to live on and you wish to leave that extra money to your children while minimizing the tax on such transfer, you should seriously consider making a substantial gift before the end of the year.  Because it may not be to your advantage to give away certain property, especially highly appreciated property or business property that has been depreciated, I strongly suggest that you consult with a tax adviser before making any gift.

Step-Up in Basis Rule - Common Mistakes

When a person sells property, that person has to pay a tax on the gain from the sale. Gain is determined by subtracting the sales price of the object from the basis of such object. For example, if I sold a stock for $100 and the basis was $40, the gain would be $60.

The basis of an object is generally the price a person has paid for it. However, if you pay money to improve the object (such as buying an addition onto a house), the basis will increase. If you depreciate an object for tax purposes, the basis will decrease. To more on the basics of basis, see my post: Understanding Basis.

Notwithstanding the crazy rules for an individual who may have passed in 2010, Section 1014 of the Internal Revenue Code states that if a person holds property at the time of his or her death, it will receive a new basis equal to the fair market value of such property at the person's date of death. This is known as the Step-up In Basis Rule because in almost all circumstances, the fair market value of the assets owned by a decedent is greater than the basis of in the decedent's hands just before he or she died.

However, the Step-up In Basis Rule is really more accurately called the Fair-Market Value Date of Death because, especially in this economy, there is a chance that the date of death value is less than the basis just before death. So the first mistake many people make is in not selling assets before they pass on which they can take a loss. If you bought stock for $20,000 and now it is only worth $10,000, consider selling it. If you sell it before you die, you can take the tax loss, if you keep it until you die, your heirs cannot claim that tax benefit.

If you are an executor or an elder law practitioner, you should also be aware that you have the option of valuing all assets under Section 2032 alternate valuation date. The alternate valuation date is six months following the date of death. So let's say on the date of death the assets are worth $5,500,000 and six months following the date of death they are worth $5,000,000. Unless there is a state estate tax, you may be better off using the alternate valuation date so that the beneficiaries have a higher basis in the property, even if there is a small federal estate tax. On the other hand, if, six months after the date of death, the assets are worth more, you are not permitted to use the 2032 elections.*  (See 2032(c).) The second common mistake made by many is to not wait the six months and run the calculations for both scenarios.

So, if the beneficiaries of a descendant's property get to take appreciated property with a step up in basis, why don't people just transfer their property to a sick relative and then have them bequeath it back them when the sick relative dies. Well, unfortunately, this rarely works. Often times, it can result in a gift tax, inheritance tax or estate tax. Additionally, under Section 1014(e), if you receive a property by gift, you have to hold it for one year before your heirs can get the benefit of the step-up in basis rule. This is the third common mistake. When doing an estate administration, many practitioners and accountants fail to adequately track the basis of the assets.

*Updated on 5/5/14.  Thanks to Bob Derber for pointing out that I also made a common mistake!

The Future of Estate Tax: Will “13” Prove To Be A Lucky Number?

In my blog post of November 12, 2010, I made reference to a dinner bet I made with my father as to when a decision would be made on the federal estate tax issue. (Yes, Dad, I haven't forgotten you were right and I still owe you dinner.) At that point, we were nearing the end of a year in which there was no estate tax and we were about to revert to a tax, up to 60%, on transfers at death in excess of $1,000.000.

In an 11th hour move on December 17, 2010 President Obama signed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act into law, which reinstated the federal estate tax – but with a $5 million exemption limit and a 35% tax rate - to begin again January 1, 2011 and to sunset on December 31, 2012. Additionally, the concept of portability of the estate tax exemption between spouses was introduced.

So while we achieved relative certainty for two years, January 1, 2013 now marks the unlucky date of reversion to the $1 million estate tax exemption, estate tax rates as high as 60%, and an elimination of the portability provision.

To provide longer term certainty, President Obama, in his recently proposed 2012 budget, is hoping to change the estate tax exemption to $3.5 million, the same as it was in 2009. Additionally, he is seeking to reduce the gift tax exemption and GST tax exemption to $1,000,000 with an increase in the estate and gift tax rates to 45%. The proposal includes making portability of the exemption amount between spouses permanent, for a combined exemption up to $7 million.

You can look at President Obama's approach in two ways. You consider this change as increasing the estate tax (by raising the tax rate and lowering the exemption from its current level). However, you can also consider this reducing the estate tax (by lowering the tax rate and raising the exemption from what would happen in 2013 if nothing were done.) All I hope for is an end to these constant changes. It will be lucky for everyone when we have certainty, beyond two years, on the issue of the estate tax.

I should note that uncertainty is likely to remain as I doubt Congress will agree with President Obama's plan. Republicans control the House and they are still looking for a full repeal of what they call “the Death Taxes.”
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Thank you to my paralegal, Elizabeth Carter, for help with this post.

Federal Estate and Gift Taxation of Deathbed Gifts

Often times, a person who is on his or her deathbed will wish to make gifts to family members. A gift is usually considered a deathbed gift if it is made within three years of a person's death. However, except for certain transfers discussed below, when a gift is made is often irrelevent for federal estate tax purposes because there is a lifetime lookback, not just a three year lookback.

Making gifts in a way that minimizes taxes is actually a very complex process. In deciding whether to make a gift, one must consider the amount of the gift, the type of asset you wish to transfer, to whom it is going to and the basis in the gifted item. I will not be discussing advanced topics such as discounted gifts or generation skipping tax transfers in this post.

The Tax Effect of a Gift

To understand the effect of a gift for federal estate and gift tax purposes, we need to start with a short discussion of the current law.

United States citizens and permanent resident aliens currently can give away an unlimited amount to a US citizen spouse or a charity without incurring a gift tax or an estate tax. US citizens and permanent resident aliens can give away up to $5,000,000 to anyone else. This is known as our lifetime exemption amount, unified credit amount or applicable exclusion amount. (Note, transfers to a spouse who is a permanent resident alien are not unlimited, they are capped by the lifetime exemption amount.)

After 2012, this $5,000,000 amount will be reduced down to $1,000,000 unless the legislation is modified. (I think it is highly unlikely that it will go back down to $1,000,000, but $3,500,000 is quite plausible.) Gifts of less than the $5,000,000 lifetime exemption amount will not result in a tax; they merely reduce the donor's exemption amount and the amount the donor can transfer on death.

In addition to the lifetime exemption amount, each person can make annual exclusion gifts without any tax liability. Annual exclusion gifts are also known as 2503(b) gifts. Gifts in excess of the annual exclusion amount (currently $13,000 per donee per year) are taxable for federal gift tax purposes. When I say that gifts in excess of the annual exclusion amout are "taxable", that means the gift reduces the donor's lifetime exemption, or, if the lifetime exemption has been used up, these transfers will result in a taxable gift. Currently, the gift tax rate and estate tax rate are 35%.

To complicate matters, if the donor is married, he or she can "split" the gift with his or her spouse. For example, let's say I gift $7,000,000 to my two children. If I make the gift alone, $26,000 of the gift is sheltered by my annual exclusion amount ($13,000 for each child). The balance, $6,974,000, reduces my lifetime exemption from $5,000,000 to $0 and results in a taxable gift of $1,974,000. At 35%, the tax on this gift would be $690,900. However, if I had split that gift with my wife, we could also use her annual exclusion amount making the taxable gift to the kids only $6,948,000. Additionally, the taxable gift would be split in half, reducing each of our lifetime exemptions to $1,526,000 and no gift tax would be due.

Gift splitting is available to married couples if each spouse is either a citizen or a resident of the United States. (I.R.C. 2513) In other words, you may gift-split with a non-citizen spouse provided he or she is resident alien.

The power of gifting using the annual exclusion exemption cannot be emphasized enough. If you have an elderly widow who has $8,000,000 who gifts $13,000 to each of her children (4),each of her grandchildren (10) and each of the spouses of her children and grandchildren, that widow can give away 28 gifts of $13,000 tax free. That's $364,000. If she does that for 9 years until she dies, she can pass on 100% of her estate to her heirs without any federal estate tax. If she had kept the $8,000,000 until her death, there would have been a $1,050,000 federal estate tax.

To get a better idea of the power of lifetime gifting using the annual exclusion amount, read my blog post on deathbed transfers in New Jersey in which I discuss gifts by Tabitha and Genie.

For all gifts discussed to this point, it would not have mattered when the gift was made. Gifts equal to or less than the annual exclusion amount do not count against the $5,000,000 exemption amount while those in excess of the annual exclusion amount do regardless of when they were made. It is now time to learn about about some special rules.

Gifts of Certain Assets are Subject to a Three Year Lookback Rule

Many people assume, incorrectly, that proceeds from life insurance policies are paid to the beneficiaries free of tax. While this is true that there is no income tax on such proceeds, it is not true for the estate tax. If a decedent OWNS a life insurance policy insuring his or her own life, the entire death benefit is includible the decedent's estate, regardless of who the beneficiary is. If the value of this death benefit plus the decedent's other assets result in the decedent having an estate over the $5,000,000 limit, the overage will result in a federal estate tax unless the estate is entitled to a marital deduction or charitable deduction.

Under Section 2035 of the Internal Revenue Code, certain assets that are transfered by a person who dies within three years are considered to be owned by the person at his or her death. This rule most significantly applies to the transfer of life insurance policies. So, if a decedent transfered OWNERSHIP of a policy on his life to another party within three years of death, the 2035 rule kicks in and it is considered a taxable deathbed gift equal to the full face value of the policy - not just the value of the policy on the date of the gift.

You should also be aware that the Section 2035 lookback rule also applies to the release of certain interests in trusts and real estate. Additionally, if the decedent paid any gift taxes within three years of death, that will be added back into the donor's gross estate, and the donor will get a credit for the taxes paid. Since these items do not affect most people, I will not discuss them in depth.

Gifts in Which the Donor Retains an Interest or Control

There are many ways to make a gift. I can give you a house or I can draft a deed, keeping a life estate for myself and then giving you the house when I die. I can give you 30% of my company or I can give you 30% of my company and retain the right to vote your stock.

The general rule is that if I make a complete gift, retaining no interest or control, it is a completed gift and will not be includible in my gross estate. If I retain any control or interest, such as a life estate or a right to vote your stock, then the gift, even though complete, will still be includible in my gross estate.

I can also fashion a gift in a manner in which there is a chance that I receive the property back. For example, I can give you a property for your life and then to your father if he survives you, but if he doesn't survive you, I get the property back. If you are much younger than me, there is a small chance that I will get the property back. If you are much older, than the chance I will get the property back is much greater. The probability that I will receive the property back is calculated as of the moment before my death, so the fact that I died before you is irrelevent. If the chance that I would have gotten the property back is greater than 5%, then the value of the property at the time of my death is includible in my gross estate.

What's the big deal if the property is includible in my gross estate if there's a lifetime lookback? Well, let's back to the example in which I transferred a 30% stock interest. Assume that at the time of the gift the 30% interest of the stock was $1,000,000 and at the time of my death that same interest was worth $7,000,000. If I had not kept an interest in the stock, it would have just reduced my lifetime exemption by $1,000,000. By keeping the voting interest, the full $7,000,000 value will be included in my estate resulting in a federal estate tax of $700,000 (35% of $2,000,000).

The Importance of Knowing the Basis of the Gifted Item

As discussed on my post on deathbed transfers in New Jersey it is wise to know the basis of the property that is being gifted. If the donor is gifting an asset, the recipient receives the gift with the same basis as it had in the hands of the donor. This is known as a carry-over basis.

Accordingly, if the donor gifts an asset that it is highly appreciated, it will result in a substantial capital gains tax when the donee ultimately sells it. If, on the other hand, the donor gave the item to donee on his death, the asset would take on a basis equal to the fair-market value of the property as of the date of the donor's death.

Due to the carryover basis rule, it is usually best not to give away appreciated property during life. It is better to either gift away cash or hold on the the asset until death and have the beneficiaries pay a smaller estate tax.

The Benefit of Making Taxable Gifts

Reading through this post, the benefit of making gifts equal to or less than the annual exclusion amount is quite evident, but you may be asking yourself why anyone would wish to make a taxable gift that uses up a person's exemption amount. Look back to the situation where the donor gave away a 30% interest in stock worth $1,000,000 and that stock grew to $7,000,000. It is much better, for tax purposes, if that grows in the hands of someone other than the person who is likely to die first. This technique is known as an "estate freeze" because reduces the chance of assets growing in the donor's hands.

Filing requirements for Taxable Gifts

You should also be aware that if you do make a gift in excess of the annual exclusion amount, you should file a federal gift tax return (Form 709).

Deathbed Transfers in New Jersey

Often times, a person who is on his or her deathbed will make gifts to family members in an effort to reduce the potential taxes owed.

For transfers to anyone other than a charity, making gifts in a way that minimizes taxes is actually a very complex process. In deciding whether to make a gift, you must consider the amount of the gift, the type of asset you wish to transfer, to whom it is going to and the basis in the gifted item.

Taxes That Must be Considered When Making Gifts

There are generally six taxes that might be triggered as result of the gift. These include the New Jersey estate tax, the New Jersey inheritance tax, the federal estate tax, the federal gift tax, the capital gains tax and the generation skipping transfer (GST) tax.

I discuss all of these taxes in more detail elsewhere, but to quickly review the general purpose of each tax:

1. The New Jersey estate tax is imposed by the state on transfers at death to the extent the decedent's net estate exceeds $675,000 and the money passes to someone other than a charity, surviving spouse, domestic partner or civil union partner.


2. The New Jersey inheritance tax is also a tax imposed on transfers at death. However, the inheritance tax is based more upon who the money is going to rather than the amount involved. New Jersey does offer a dollar for dollar credit against its estate tax for any inheritance tax paid.


3. The federal estate tax is imposed by the federal government on transfers at death to the extent the decedent's estate exceeds $5,000,000 and the money passes to someone other than a charity or a surviving spouse.


4. The federal gift tax is imposed by the federal government on transfers during a person's lifetime to the extent the person's lifetime gifts exceed $5,000,000 and the money is transferred to someone other than a charity or a spouse.


5. The generation skipping transfer tax (also known as the GST Tax) is generally assessed by the federal government on transfers during life or at death to a person's grandchildren, or more remote descendants to the extent such transfers exceed $5,000,000.


6. The capital gains tax imposed on the sale of appreciated property, stock or similar assets.

As you may have noticed, only four of the six taxes named above are directly attributable to a transfer being made as the result of someone dying. The reason that a lifetime gift can be taxed at the donor's death is because New Jersey and the federal government have lookback provisions. Lookback provisions basically say that if you make a certain kind of transfer, the government can tax it at your death even if you gave the money away during your life. As you can imagine, this creates a host of problems including finding a way to pay for the tax.

What is a Deathbed Gift?

New Jersey defines deathbed gifts as gifts made in contemplation of death (N.J.S.A. 54:34-1(c)). People usually know the deathbed gift rule as the three year lookback rule because gifts made within three years of death are presumed to be in contemplation of death. If a gift is made in contemplation of death, and the gift was over $500, then New Jersey asserts it was really a transfer at death subject to the inheritance tax.

For New Jersey tax purposes, this particular three year rule ONLY appears under the NJ inheritance tax statutes. There is a very different rule for the New Jersey estate tax because the New Jersey estate tax generally follows the federal estate tax for determining what is taxable and what is not taxable. I will discuss this in more detail below.

Since gifts made in contemplation of death are subject to an inheritance tax, and the inheritance tax only applies for transfers to certain beneficiaries, it is important to know how New Jersey classifies the beneficiaries of the gift.

Determining the Class of the Beneficiary

To determine if a lifetime gift will result in a New Jersey inheritance tax, the first thing that you must do is differentiate between gifts made to Class A beneficiaries, Class C beneficiaries and Class D beneficiaries.

Class A beneficiaries include the decedent's spouse, civil union partner, domestic partner, all lineal descendants (such as children, grandchildren and great-grandchildren), all lineal ascendants (such as parents, grandparents and great-grandparents) and step-children. An adopted child, grandchild or great-grandchild is also considered a lineal descendant. Transfers to Class A beneficiaries are exempt from the NJ inheritance tax, meaning there is no inheritance tax on deathbed gifts or transfers at death to such individuals.
Class C beneficiaries include the decedent's brother or sister and son-in-law or daughter-in-law of the decedent even if the decedent's child is also deceased. Class D beneficiaries includes everyone else (most notably nieces and nephews).

If the gift is made to a Class C Beneficiary, and the gift was over $25,000, there definitely will be a NJ inheritance tax if the gift was made "in contemplation of death". If the gift was made more than 3 years prior to the decedent passing, it will not be subject to a NJ inheritance tax.

If the gift is made to a Class D Beneficiary, and the gift was over $500, there definitely will be a NJ inheritance tax if the gift was made in contemplation of death. If the gift was made more than 3 years prior to the decedent passing, it will not be subject to a NJ inheritance tax.

If the deathbed gift is subject to the New Jersey inheritance tax, there will be a tax due of 11-16% of the transferred amount. There is an 11-16% tax on transfers to Class C beneficiaries on the gifted amount in excess of $25,000 and a 15-16% tax on the entire transfer to Class D beneficiaries if the gift is in excess of $500. The more that is transferred, the higher the rate will be.

As an example, assume I owned $5,000,000, and I gifted away $1,000,000 to my nieces and nephews four years ago, $3,500,000 to my nieces and nephews this year and then died within three years, leaving the remaining $500,000 to my two siblings. The $1,000,000 gift to my nieces and nephews would not be subject to a New Jersey inheritance tax because it was longer than three years ago. The first $700,000 of the $3,500,000 deathbed gift to my nieces and nephews would be taxed at a 15% inheritance tax rate ($105,000). The remaining $2,800,000 would be taxed at a 16% inheritance tax rate ($448,000). For the transfers to my siblings, $50,000 will pass free of taxes, and the remaining $450,000 will be taxed at an 11% inheritance tax rate ($49,500). In total, there will be a $602,500 NJ inheritance tax.

For gifts to charity in any amount and gifts of less than $500 to any person, there is an easy answer - it is not subject to an inheritance tax in New Jersey.
Regardless of what classification a beneficiary is in, there MAY BE a New Jersey estate tax and/or federal estate tax if the gift is subject to a three year lookback under the federal estate tax rules or a lifetime lookback if the gifted items are in excess of the annual exclusion amount.

Certain Transfers are Automatically Subject to a Three Year Lookback for Estate Tax Purposes

Under Section 2035 of the Internal Revenue Code there is a limited three year lookback that most significantly applies to life insurance policies transferred within three years of death.
A. Life Insurance: If you learn nothing else from this post, make sure you learn this:

1. If a decedent OWNS a life insurance policy insuring his or her own life, the entire death benefit is subject to both the New Jersey estate tax AND the federal estate tax. Many people assume life insurance proceeds are tax free. While this is true for income tax, it is not true for estate tax. The only relief is if the beneficiary is a charity, a surviving spouse, a civil union partner or domestic partner because then the estate may be entitled to a deduction;


2. If the decedent transferred OWNERSHIP of the policy on his life to another party within three years of death, the 2035 rule kicks in and it is considered a taxable deathbed gift.

B. You should also be aware that the Section 2035 lookback rule also applies to certain interests in trusts and real estate. This does not affect most people, so I will not discuss them here.

Gifts in Excess of the Annual Exclusion Amount

Currently, each United States citizen and permanent resident alien can give away $13,000 to as many donees as he or she wishes. This is known as the federal annual exclusion amount or 2503(b) exclusion. Gifts in excess of the federal annual exclusion amount result in a "taxable gift". Usually there is no immediate out of pocket expense though because New Jersey does not have a gift tax and the federal government will only institute a gift tax if the sum of these gifts exceeds the lifetime exclusion amount (currently $5,000,000).

When calculating the New Jersey estate tax, we are required to look not just at what a person owned when he or she died, but also the taxable gifts that the decedent made over his or her lifetime.

In most situations, if the decedent's taxable estate, including prior taxable gifts, is in excess of the New Jersey estate tax exemption amount (currently $675,000), there will be a New Jersey estate tax. However, there is a big difference in the tax depending upon whether the decedent died with estate over the $675,000 threshhold or died with an estate under the $675,000 threshhold, but is deemed to have an estate in excess of $675,000 due to the lookback provisions.

As an example, assume I owned $5,000,000, and I gifted away $4,500,000 to my daughters and then died in 2012 as a widower, leaving the remaining $500,000 in my estate to my children. Normally, there would be no estate tax on a New Jersey estate of only $500,000, but we must add back the prior gifts. Even adding back the prior taxable gifts, it would only produce a $10,000 NJ estate tax. (To learn how this is calculated, you will need to prepare a 2001 Form 706 federal estate tax return and a New Jersey estate tax return. I will discuss this in future post, entitled "Deathbed Transfers in New Jersey - Advanced")

To realize the benefit of making this gift, you should know that if I had died with the entire $5,000,000, my estate would have to pay a $391,600 New Jersey estate tax. In years past, nobody would give away more than a $1,000,000 because that was the old lifetime gift limit for federal gift tax purposes. Any gifts above $1,000,000 were taxed at a very high gift tax rate. However, with a $5,000,000 lifetime federal gifting limit and no New Jersey gift tax, there is ample opportunity for planning to avoid or drastically reduce the New Jersey estate tax.

You should also be aware that if you do make a gift in excess of the annual exclusion amount, you should file a federal gift tax return (Form 706). If a lifetime transfer is in excess of the federal annual exclusion amount, it could lead to a federal estate tax or a federal gift tax at some future time. To minimize this possibility, you should try to structure gifts over longer periods of time and for an amount equal to or less than the annual exclusion amount. To read more about this, see my article entitled: Federal Estate and Gift Taxation of Deathbed Gifts.

The Importance of Knowing the Basis of the Gifted Item

It is important to know the basis of the property that is being gifted. If the donor is gifting cash, the basis is exactly the amount of the gift. If the donor is gifting property or stock, it may be unwise to make the deathbed gift because there could be substantial built-in capital gains.

When property is gifted away, the donee usually takes the property with a basis equal to that of the donor's basis. (For more on basis, see my post on Understanding Basis.) If the donor keeps property until his or her death, the recepient will receive the property with a new basis equal to the fair market value of that property on the date of the death. This is often referred to as a step-up in basis rule, although in this economy it may be a step-down in basis.

Let's assume I give away a real estate property worth $4,500,000 to my daughters shortly before I die to save on the New Jersey estate tax. If my basis in the property was only $1,000,000, the kids will take the property with that same basis. If my kids sell it immediately after I die for $4,500,000, there will be a 15% capital gains tax on the $3,500,000 of built in gain. This will produce a federal capital gains tax of $525,000 and probably a New Jersey income tax of $315,000. As discussed above, the New Jersey estate tax would have only been $391,600 if I had held onto the property.

Due to the carryover basis rule, it is usually best not to give away appreciated property during life. It is usually better to pay a smaller estate or inheritance tax than to risk losing the step-up in basis on the decedent's death.

Summary

In summary, large deathbed gifts are not necessarily going to be taxed after the donor passes. Whether there will be a New Jersey tax on a deathbed gift is based upon whether the transaction has occurred in the last three years, to whom the item is being gifted, the type of asset being gifted and on the size of the donor's net estate after factoring in prior gifts.

When all is said and done, even if there is a New Jersey tax (estate or inheritance), large gifts made to Class A beneficiaries prior to death and large gifts made to Class C and D beneficiaries more than three years prior to death will greatly reduce the overall estate and inheritance tax liability unless the donor is making a gift of a highly appreciated asset.

Simple, right?

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I want to give a special thank you to Martin Bearg, Esq., Rekha Rao, Esq., Rebecca Esmi, Esq., and to individuals at the New Jersey Transfer Inheritance Tax Branch (who wish to remain anonymous) for taking the time to speak with me about this and helping me to gather my thoughts.

Japanese Inheritance Tax vs. US Estate Tax (2011 Update)

BRIEF OVERVIEW OF
JAPANESE INHERITANCE AND GIFT TAXES
vs.
AMERICAN ESTATE AND GIFT TAXES

(2011 Update)

NOTE: This information has been updated. The new post can be found at: http://willstrustsestates.blogspot.com/2014/08/japanese-inheritance-tax-vs-us-estate.html

I. Estate Taxes

A. America

1. Citizens and Permanent Residents

a. Tax on Worldwide property (credit for taxes paid to foreign countries)
b. Exemption of $5,000,000 in 2011 and 2012 (theoretically back to $1,000,000 in 2013 if no change to Federal Estate Tax). For married couples, the exemption amount is $10,000,000 as a result of portability.
c. Tax of 35% on amount over $5,000,000
d. Unlimited Marital Deduction for Surviving Spouse if Surviving Spouse is a citizen

2. Non-Citizens/Non-Permanent Residents

a. Tax only on Real Property and business interests in the United States (Cash in foreign banks and foreign stocks are not taxed)
b. Exemption of $13,000
c. Tax of between 18%-35% on amount over $13,000
d. Unlimited Marital deduction if Surviving Spouse a citizen

B. Japan (Actually an Inheritance tax, not an estate tax)

1. Japanese Citizens and Permanent Residents

a. Exemption of ¥50,000,000 + (¥10,000,000 for each statutory heir); Possible additional exemption for insurance money, retirement savings, and money left to handicapped individuals
b. Additional exemption for life insurance received of ¥5,000,000 multiplied by the number of statutory heirs
c. Tax between 10%-50% for statutory heirs; Tax between 30% to 70% for everyone other else (except charities);
d. For property outside of Japan, a beneficiary that acquires property will be subject to Japanese inheritance tax if the beneficiary is a Japanese national and the beneficiary was domiciled in Japan at any time during the five years preceding the receipt of the inheritance.
e. A surviving spouse is entitled to a tax deduction. This is a complex formula based upon who is living at the time of the Decedent's death and where the money goes. Generally, a surviving spouse can deduct about 1/2 to 2/3 of the tax.

2. Non-Citizens/Non-Permanent Residents

a. If beneficiary is not Japanese and not living in Japan and property is not in Japan, appears Country where property located will tax such property.
b. If there is a tax, it appears a surviving spouse is entitled to the same marital tax deduction as for Japanese citizens.

II. Gift Taxes

A. America

1. Citizens and Permanent Residents

a. Tax on all gift transfers of Worldwide property
b. Annual exemption of $13,000 per person/per donee (unlimited gifts for donees if different donors)
c. An annual gift to a non-citizen, permanent resident spouse, of $136,000 is available.
d. Lifetime exemption of $5,000,000 (for years 2011 and 2012)
e. Gifts may be split with spouse
f. Tax rate of 35% if lifetime gifts exceed $5,000,000

2. Non-Citizens/Non-Permanent Residents

a. Tax on all gift transfers of US Property (including Cash and Stocks in US companies)
b. Annual exemption of $13,000 per person/per donee (unlimited gifts for donees if different donors)
c. No Lifetime exemption
d. Gifts may be split with spouse
e. Tax rate of 18%-35% if lifetime gifts exceed $13,000

B. Japan (Rates between 10%-50%)

1. Citizens and Permanent Residents of Japan

a. Annual exemption of ¥1,100,000 for each beneficiary (beneficiary taxed after this)
b. One time spouse exemption of ¥20,000,000
c. For property outside of Japan, a donee that acquires property will be subject to Japanese gift tax if the donee is a Japanese national and the donee was domiciled in Japan at any time during the five years preceding the receipt of the gift.

2. Non-Citizens/Non-Permanent Residents

a. Annual exemption of ¥1,100,000 for each beneficiary(unclear – enforcement is almost impossible)

III. Generation Skipping Taxes (Taxes on gifts or bequests to grandchildren)

A. America

1. Exemption of $5,000,000 in 2011 and 2012 (theoretically a return to a $1,000,000 exemption in 2013, but indexed for inflation)
2. Tax of 35% on rest

B. Japan

1. None

For more information on Japanese taxes, the Japanese government has a nice website in English with some helpful facts. This is a link directly to the inheritance tax information:
http://www.mof.go.jp/english/tax_policy/publication/taxes2010e/taxes2010e_d.pdf
It is worthwhile reading the Japanese publication if you have business interests in Japan or if one of other special circumstances (like a handicapped heir) as there are many credits available.

Inflation Updates for 2011

Every year the Internal Revenue Service publishes a list of inflation adjustments. Here are the important ones that relate to Gift and Estate Taxes and others that are just useful:

1. 2011 Annual Gift Tax Exclusion will stay at $13,000. This means a person can give any other person at least $13,000 before it is subject to the federal gift tax. I won't go into the details about how and when it will qualify - just realize that as long as it is an outright gift, it will usually qualify. Also, a husband and wife may split a $26,000 gift for tax purposes before there is a gift tax.


2. 2011 Annual Gift Tax Exclusion for Gifts to Non-Citizen Spouses will be $136,000. This is the maximum amount a person may transfer to a non-citizen spouse before the gift is subject to a gift tax. In order for US law to apply, we will usually be talking about a gift being made to a permanent resident alien spouse. One place where this gets triggered unexpectedly by many is retitling of real estate - so be give careful thought to this before changing ownership. This is up from $134,000 in 2010.
   


3. The 2011 Federal Estate Tax Exemption will be $5,000,000. We've talked about this before, so it should not be a surprise to anyone that the estate tax exemption is settling at $5,000,000 for the next two years. This means that if you die in 2011, the federal government will not have a death tax on the first $5,000,000 that you pass on (unless you have made large gifts in previous years).
   


4. The 2011 Federal Lifetime Gift Tax Exemption will also be $5,000,000 for the next two years. This is in addition to the annual gifts that a person can make. Beware of gifting highly appreciated assets!
   


5. 2011 Reporting Requirements for Large Gifts Received from Foreign Persons: recipients of gifts from certain foreign persons may be required to report these gifts under § 6039F if the aggregate value of gifts received in a taxable year exceeds $14,375.


6. 2011 Mileage Reimbursement Rates: the standard mileage rates for the use of a car (also vans, pickups or panel trucks) will be:
• 51 cents per mile for business miles driven
• 19 cents per mile driven for medical or moving purposes
• 14 cents per mile driven in service of charitable organizations

Source: IRS Rev.Proc. 2010-40 & IR-2010-119 & IRC Section 2001

Federal Estate Tax Reform 2011

As you may be aware, President Obama recently signed the “Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010”. In addition to keeping most of the income tax rates at their 2010 levels, this Act includes a major change to the federal estate tax.

Summary of the New Tax Law

Starting in 2011, each United States citizen and permanent resident alien will be entitled to a $5 million lifetime gift and estate tax exclusion amount. Anything over $5 million will be taxed at 35%. This means that starting January 1, 2011, you will be able to give away $5 million dollars either during your lifetime or at your death… but only for 2 years. This new tax law sunsets at the end of 2012.

Another major change in the federal estate tax law is that it allows for the transfer of a decedent’s estate tax exclusion amount to his or her surviving spouse. This is known as the portability provision. So let’s say a husband dies in 2011, leaving $3 million to his children; his widow can receive his $2 million in unused exclusion amount so that if she dies in 2012 she can pass on $7 million to her children free of the federal estate tax. This is a major boon to couples who fail to prepare a Will and for couples who have not equalized their estates.

So How Does the New Tax Law Affect You?

For 99.5% of the population, it means that you will not have to pay a federal estate tax if you pass away in 2011 or 2012, and you may or may not have to pay a huge estate tax if you die after that. Tax planning must be done to deal with state estate and inheritance taxes as well as the possibility that the federal estate tax will return in full force in 2013. Additionally, traditional estate planning documents should still be prepared to direct where assets go, set up trusts for children, nominate executors, guardians and trustees, where necessary, avoid probate.

It is also important to remember:

1. In Florida, the benefits of setting up a revocable living trust and avoiding probate remain unchanged. Additionally, if you own real estate in another jurisdiction other than Florida, you may have to pay an inheritance tax or estate tax in that jurisdiction.
2. New Jersey still has an estate tax that applies to anyone who dies with more than $675,000 in assets and New Jersey DOES NOT have a portability provision. Furthermore, New Jersey also has an inheritance tax, up to 16%, on transfers to certain individuals, including siblings, nieces and nephews and friends.
3. New York still has an estate tax that applies to anyone who dies with more than $1 million in assets. Moreover, New York DOES NOT have a portability provision and it is strongly recommended that clients title their assets in a way that will avoid probate.
4. Pennsylvania still has an inheritance tax of up to 15% that applies to everyone who plans to leave assets to anyone other than a spouse or a charity.

In most cases, the new law should not affect most of the documents that competent attorneys will have drafted over the last 5 years. However, I highly recommend estate planning documents should be reviewed if they were drafted by an attorney who does not focus on tax planning or if you have had changes in your personal life or a substantial change in your wealth.

The new tax law also provides ample opportunity for gift planning, including gifts to trusts; however, such gifting could also have negative capital gains tax implications if done incorrectly.

As always, I am available for a consultation if you have any questions.

The "Gift" of Health Insurance

I frequently come across clients who want to help their children financially, but they do not want to give them money directly. There are numerous ways to do this, including:
1) gifting an interest in a limited liability entity (such as an LLC, an S-Corp or a limited partnership);
2) making gifts to a child via a trust;
3) paying for a child's or grandchild's tuition; and
4) paying for a child or grandchild's medical expenses.

In the first two categories, there is a limit to the amount that can be given tax free. This amount is known as the 2503(b) exemption amount, and it currently stands at $13,000. However, for the third and fourth categories, a parent can pay educational and medical expenses for a child, regardless of amount, and not have to worry about paying a gift tax at all.

When many people consider making a gift for medical purposes, they think that they have to pay the doctor directly on behalf of the child. There is something else that can be done though - they can also pay their child's health insurance premiums. According to Treasury Regulation 25.2503-6(3), "the unlimited exclusion from gift tax includes amounts paid for medical insurance..."

Since insurance premiums have been increasing by double digit percentages almost every year, wealthy parents should take advantage of this option to help out their children and provide piece of mind to themselves. This is particularly true if their child has been laid off in this down economy.

By directly paying the insurance company for their child's health insurance bills, parents can also make an additional $13,000 gift (either in cash or indirectly), to help out their child or minimize their estate for estate tax purposes.

The Importance of Planned Gifting

One of the best ways to minimize your taxable estate is through planned gifting. Anyone who may be subject to a federal or state estate tax, or a state inheritance tax, should at least consider a gifting plan.

The first item to think about is - can you afford it? This is not always an easy question because you may be worth a lot of money, but you might not have a large income to cover your annual expenditures. Accordingly, sometimes the best items to gift are items that do not produce a lot of income, but are worth a lot of money for estate tax purposes. Vacation homes, valuable art collections and a minority interest in a business are all perfect examples of this.

Once you figure out whether you can afford to make a gift, the second question is how much to gift and who do you wish to benefit. These go hand in hand because often times you only wish to benefit certain people or certain charities by a set dollar amount rather than by everything you can afford to give away.

When trying to calculate how much to gift, valuation of the gift becomes crucial. It is beyond the scope of what I wish to discuss here, but be aware that certain gifts may valued at less than you think because discounts should be taken if the gift is not freely marketable and/or the donee does not have much control over the asset after it is received.

Additionally, tax law often plays a key role in how much you give away. Even if you can afford to give away $2,000,000 to charity or to your grandchildren, it may be more beneficial for tax reasons to make smaller gifts over a number of years rather than a large lump sum gift.

This leads us to the third item that we must think about in a gift plan is the timing of the gift. (For more information on this, see my earlier blog post on timing.) You may be aware that the federal government allows you to gift away a certain amount every year (currently $13,000) without a gift tax consequence. Moreover, you may gift away up to $1,000,000 before there is any out of pocket gift tax consequence because you are entitled to a $1,000,000 federal gift tax exemption.

Any good gifting plan is going to try and make maximum use of your lifetime gift tax exemption, annual exclusion amounts as well your ability to pay for another person's educational or medical expenses without incurring any tax consequences. (There is technically no gift if you make payments, for the benefit of another person, when such payments are made directly to certain educational institutions or medical care givers.)

Due to the annual exclusion allowance, practitioners frequently encourage clients to make gifts to their loved ones over the course of many years.

The final item to think about, is the manner in which the gift is made. There are thousands of different ways to make gifts. You can make gift directly to the person or charity you wish to benefit. You can make a gift via a trust (and there are many different trusts such as insurance trusts, charitable lead or remainder trusts, dynasty trusts with or without withdrawal rights, qualified personal residence trusts, etc.). You can make gifts to a 529. You can give away partial ownership of a property. You can have an indirect gift by "giving" money to a company in which you are not the sole owner and not getting anything in return for that extra contribution. You can give up a power that you were entitled to.

Once you have figured out what you can afford, who you want to benefit, how much you want to give, when to make the gift and how to make the gift - then you have a truly planned gift.

NOTE: All items discussed here assume that you are a US citizen or permanent resident alien.

Timing of a Gift

When doing gift planning, it is imperative to have the gifts completed on the schedule that you want otherwise you may accidentally gift too much one year, causing a tax, or you may gift too little, and lose your annual gift tax exclusion for the year.

Therefore, you must know the answer to this question: When is a gift complete for purposes of the federal gift tax?

Unfortunately, tax law is much like a magic trick - what may appear to be true is not always true. If you give someone cash, is the gift is complete the moment the other person receives the cash? What about a check? What about a transfer of real estate by deed?

Would it make a difference if, when giving you the cash, I told you that you could only spend it on a new car, otherwise I want it back? What if there was not enough cash in the account to cover the check? What if after making the deed I held it and did not show it to anyone else or record it? Things get trickier then...

Three elements are required to establish a gift: "(1) donative intent on the part of the Donor; (2) an actual or symbolic delivery of the subject matter of the gift; and (3) an absolute and irrevocable surrender by the donor of ownership and dominion over the subject matter of the gift, at least to the extent practicable or possible, considering the nature of the thing to be given." (Jennings v. Cutler, 288 N.J. Super 553 (App. Div. 1996)

Donative intent means that the person making the gift (or the Donor) believes in his own mind that he is giving something away. For example, if I give you cash, but I expect you to repay it, it is not a gift - even if I do not tell you at the time that I want to be repaid. Since I expect to be repaid, I do not have the proper mindset, or intent, to qualify this as a gift.

The moment that I no longer wish to be repaid, then that transfer can be a completed gift if the other requirements are met. Often times practitioners make positive use of this intent requirement. We can draft a promissory note for a parent transferring a large sum of money to a child, whereby the child agrees to pay back $X per year. The parent can then forgive that annual repayment, thereby completing a gift as to $X. This technique is commonly used by a parent who wishes to help a child make a down payment on a house, but does not want to use up their lifetime $1,000,000 gift tax exemption. The payments of $X can be structured to be less than or equal to the annual exclusion amount, thereby passing on additional money free of gift and/or estate taxes.

To have actual or symbolic delivery is important because it puts the person receiving the gift (the donee) on notice that they are receiving something. Let's go back to the example of a person making a deed for the benefit of their child and then keeping hidden away from the world. It would be similar to make saying to myself that I'm going to give each of my blog readers $100,000, putting the money in my sock drawer, but not telling you about it. I may have the proper intent, but unless there is some further act, it is not enough.

What further act is necessary puts us into a gray, mushy area of the law. I do not physically have to give you the gift. Some sort of act in furtherance of the gift is enough. Three situations that come up frequently are the writing of a check, the preparation of a deed and the transfer of a business ownership interest, so I will discuss them a bit further.

If you write a check to another person, the gift becomes complete when you've gone that extra step to ensure the other person receives the check. This could mean physically handing it to them or putting it in the mailbox. If there is not enough money to cover the check in your account, the gift would not be complete until there is enough money in the account to cover it. (This gets into another gray area however if bank covers your check.) If, however, you tell the donee not to cash it yet, and they obey, then the gift is not complete until they receive permission to cash the check.

For the gift of real estate, the donor does not necessarily have to record the deed, but the recording of a deed clearly proves the gift was made. (see Fischer v. Gerndt, N.J. Eq. 53, 55 (Ch.1922). Anything short of the deed being recorded puts us in yet another mushy gray area of the law. You could give the deed to the donee to record, which would complete the gift, but then take out a mortgage, negating the gift. You could give the deed to the donee's agent, which would complete the gift, but then sell it that same afternoon to another party, negating the gift. Ultimately, it would be an after the fact determination. Accordingly, when doing gift planning, you should not wait until the end of the year to transfer real estate, because it can take up to a month to record the deed. As stated in the beginning, timing is everything for proper gift planning.

For a gift of a business interest, the donor does not necessarily have to enter something in the stock book or file something with the state, but doing so clearly completes the gift. A letter by the donor to the donee stating, "I hereby give you 10% of XYZ business" could be enough, unless the donor turns around quickly and sells it to someone else. As with the deed, for proper planning, it is best just to take the appropriate steps to make the gift clearly complete.

With respect to the final requirement, "an absolute and irrevocable surrender by the donor of ownership and dominion over the subject matter of the gift, at least to the extent practicable or possible, considering the nature of the thing to be given", it is actually a mouthful but easy to show by example. If I tell you that you can have my art collection when I am done with it - it is not a gift until I tell you I'm done with it. In the example at the beginning, the gift of cash subject to the fact that you can only use it for a new car, the gift is not complete until you either use it for the new car, or I change my mind and agree you can have it no matter what. Generally, you have to give up control of what you are gifting. When you have done that, this element is satisfied.

For more on the importance of planned gifting, see: The Importance of Planned Gifting

Note: Thanks to Paul Kostro for keeping me up to date on much of this information. Paul's Blog can be found at: http://www.kostrolaw.com/NJFamilyIssues/

Links to Important US-Japanese Tax Treaties

It is not always easy to find the treaties between America and Japan, so I have decided to post them here in case you would like to read them for yourself.

Here is the US-Japan Income TaxTreaty (2003) courtesy of the IRS.

This is an official version of the US-Japan Estate & Gift Tax Treaty (1954) thanks to the Ministry of Foreign Affairs of Japanese.

Perfect Time to do Estate Planning for that Vacation Home

Sometimes in a bad economy, opportunities present themselves. One great planning opportunity that currently makes a lot of sense is a special trust known as a QPRT (Qualified Personal Residence Trust). A QPRT is great way to pass on wealth to your heirs in a tax efficient manner and without affecting your more liquid assets.

Here's generally how it works:
1) The owner of a property places a personal residence (or vacation home) in trust. The owner can continue to live in and use the property for a set number of years. At the end of the term, the property goes to whomever the owner wants, typically the owner's child or into another trust for the benefit of the child.
2) This gift is a legally enforceable promise to make a gift of the property to the child in X years from now. So, if the house is worth $500,000, and you promise to give it to your daughter 7 years from now, it is not really a $500,000 gift due to the time/value of money. The actual amount of the gift depends upon a variety of factors including the age of the donor and the current interest rate.
3) This plan can produce large estate tax savings. Giving away property while you are alive is an estate planning tax strategy known as an estate freeze. You are giving away property now so that future growth occurs in the estate of your heirs, rather than in your own estate. A QPRT leverages this strategy so that you are combining a discounted gift with an estate freeze.

• Assume the following hypothetical. A wealthy 70 year old woman (worth $3,500,000) lives in New Jersey and has one adult son. She owns a shore home worth $1,000,000. Now, upon this woman's death, in New Jersey, she may bequeath $675,000 before having a NJ estate tax. Under current federal law, she can bequeath $3,500,000 before she has a federal estate tax. There is no limit to what she may gift away during life according to NJ, but the federal limit is $1,000,000. After that, there is a federal gift tax.
  
• This woman decides to give away her shore home, worth $1,000,000, to her daughter. She structures the transaction so that the term of the QPRT is 7 years. This results in a taxable gift for federal gift tax purposes of $657,300 based upon the woman's age, the term of the trust and the March 2009 Section 7520 rate. There is no NJ gift tax.
  
• Now, let's fast forward 7 years and 1 day, when the woman passes. I will assume the value of the shore property increased to about $1,300,000 and the rest of her estate only modestly increased from $2.5 Million to $2,700,000. If she had not given anything away, then at the time of her death her estate would have equaled $4,000,000. Assuming that the federal estate tax exemption remains at $3,500,000 and the New Jersey Estate tax exemption remains at $675,000, then her estate would have a combined estate tax liability of approximately $505,400 ($225,000 federal and $280,400 New Jersey). By making this gift via a QPRT, we completely elimiate the federal estate tax and the New Jersey estate tax would be reduced to approximately $155,600 - a savings of $349,800. (To compare with an outright gift of property, the combined estate tax would be $245,600, a savings of only $259,800.)
  

Traps to be wary of:
1) Be careful about giving away highly appreciated real estate unless you are quite sure the donees plan to keep it in the family for a long time. This is because the donees receive the gift with a carryover basis and could be subject to a very large capital gains tax upon the sale of the property.
2) Do not use this technique if the donor is in poor health. Setting up a QPRT is most effective when the donor survives the term of the trust. If the donor does not survive, then the property is included in his gross estate for both federal and state estate tax purposes.
3) For the same reason as Trap #2, it is best not to set up too long of a term. The longer the term, the greater the risk that the donor will pass. In my opinion, a term longer than 10 years usually produces a risk that outweighs the benefits of obtaining a discount on the gift. This is especially true now that the federal estate tax exemption has increased.
4) If the donor is married, it is usually best to set up two QPRTs, with the wife giving away her half in one QPRT and the husband giving away his half in the other. This technique increases the chance that at least one person will survive the term.
5) This technique works even better when there is a high interest rate, so if the owner has an estate subject to the federal estate tax, the best time to do a QPRT is when the value of the property value is low, but the AFR (applicable federal rate) is high.

In conclusion, this is still a great time to do gift planning, but you should consider doing so with assets that are not as liquid.

Note: QPRT calculations done courtesy of Adam Epstein at Bernstein Wealth Management.