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Estate and Gift Taxes
Whether we're discussing income, sales, capital gains, or property taxes, all of us have to deal with taxes in some form or another. After all, April 15th would not mean anything if it weren't for taxes. It doesn't matter if it's a flat tax, graduated tax, or an upside down tax... taxes are the largest expense and a major problem for us all. Taxes play a large factor in developing an effective estate plan, and eventually funding it. The largest tax bill, unfortunately, comes when you are long gone and have already become an angel... that's the day your estate taxes are due.
Estate taxes? Don't we pay enough in taxes? Yes we do. In fact, according to one Washington think tank, the average American spends more paying taxes than buying food, tobacco, clothing, and housing combined. One of our never-ending goals is to minimize taxes as much as possible, preserving wealth for yourself and loved ones. That goal does not changed when it comes to effective estate planning. And with good reason. Estate taxes (which mirror gift taxes) can get much higher than your personal income tax, with rates climbing as high as 46%! This is how the IRS calculates your estate tax bill:
By using the tax chart,
you can estimate what your estate taxes will be. For instance, suppose
you have an estate worth $2.1 million. With the above chart, you would
fit between the $2,000,000 and $2,500,000 category.
Your estate tax equals $780,800 for the first $2 million, plus 46% tax on the leftover: Estate Taxes = $780,800 + $100,000(0.46) = $826,800
When you gift over $1 million to grandchildren (effectively "skipping" a generation), the IRS slaps a double tax on you. In fact, the IRS treats such a gift as "two gifts in one" and slaps a 46% tax on the gift twice. When such a gift is hit once with a 46% tax... and then again with another 46% tax, the gift is effectively reduced by 72%! That means $1 million of your hard-earned wealth immediately shrinks to just under $280,000 for your heirs, with the remainder going to Uncle Sam.
Congress has created uniform tax rates for gifts and estate transfers of wealth (also known as the Unified Gift and Estate Tax Rates). However, since 2002, Uncle Sam has provided different tax credits to gifts and estate taxes. The Estate Tax Credit allows every American citizen to pass a certain amount of their estate to heirs tax-free. Unlike the Gift Tax Credit, a $1 million exclusion which can be used during one's lifetime (e.g. a father wishes to gift money to his daughter), the Estate Tax Credit can be used after someone has died and the estate is being distributed. With the Taxpayer Relief Act of 1997 and the Tax Relief Act of 2001, the Estate Tax Credit has gradually been increasing. At the same time, the top tax rate will be decreasing until 2010, when estate and gift taxes are fully repealed. However, in 2011, estate taxes return to their 2002 levels. Here's a breakdown
of the Estate and Gift Tax Credits and top Unified Tax Rates:
As the table demonstrates, the Gift Tax Credit is not as large as the Estate Tax Credit. For gifts made in 2002 or later, the gift tax maximum exclusion was locked at $1 million. This gift tax exclusion remains in effect for subsequent years. Only in 2011, when the Estate Tax Credit returns to $1 million, will both credits be equal (and "unified"). Estate taxes are due to the IRS only 9 months from date of death. In many cases, heirs and loved ones are forced to sell personal property, real property, and other belongings at below market value to pay for this huge tax bill.
While you can never completely eliminate estate taxes, you can effectively reduce them with different types of trusts. Planning is a must. Many people with large estates, who create a simple living trust, often overlook their largest tax liability (and they won't even be around to pay it).
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