Is 2012 the year to act on estate, gift planning? - East Valley Tribune: Ahwatukee Foothills

Is 2012 the year to act on estate, gift planning?

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Posted: Tuesday, July 17, 2012 2:58 pm

You may have heard that under current law a variety of federal taxes are scheduled to increase effective Jan. 1, 2013. Two of those taxes are the federal estate and gift taxes. Under current law, each U.S. citizen or resident enjoys a $5.12 million exemption from estate and gift tax; the value of an estate or a gift in excess of the exemption is subject to tax at a rate of 35 percent. Effective Jan. 1, 2013, the exemption decreases to $1 million, and the rate increases to 55 percent. As stark as those figures may be, for most of us they beg more fundamental questions. This article addresses a few of the most common questions.

Q: What is the federal estate tax?

A: The federal estate tax is a tax on your right to transfer assets at your death. The “death tax.” In general, all assets that you own or control are includable in your estate for estate tax purposes and subject to estate tax at your death.

Q: What is the federal gift tax?

A: The federal gift tax is a tax on your right to gratuitously transfer assets during your life to or for the benefit of another individual. To the extent you transfer an asset during your life and do not receive the fair market value of that asset in exchange, you have made a gift subject to gift tax.

Q: Does an individual enjoy two $5.12 exemptions — one against the estate tax and another against the gift tax?

A: No. The exemptions are unified under current law. To the extent you use the exemption to shield gifts from tax during life, the exemption available at death to shield the estate from estate taxes is reduced. For example, if an individual made $3 million of gifts last year and then died this year, the individual’s estate would have $2.12 million in exemption ($5.12 total exemption minus $3 million exemption used last year). Of course, a married couple enjoys a $10.24 million collective exemption under current law. This becomes $2 million on Jan. 1, 2013.

Q: What about my ability to make gifts of $13,000 per year?

A: This is referred to as the “annual exclusion,” which used to equal $10,000 and has increased to $13,000. In general, a donor-individual can transfer up to $13,000 each year to each of as many individuals as the donor pleases without having to report the gifts (assuming no gifts other than annual exclusion gifts were made in the year in question). The annual exclusion does not count against the exemption — it is separate and distinct from the exemption.

Q: What are the income tax characteristics of a gift?

A: A gift is not included in the gross income of the donee. In general, the donee takes a “carry-over” (income tax) basis in the asset received by gift, typically meaning that donor’s cost of the asset is the donee’s income tax basis in the asset. In other words, any unrealized gain in the asset is preserved in the hands of the donee — the IRS is still going collect the capital gain tax when the asset is ultimately sold.

Q: What assets are included in my estate for estate tax purposes?

A: In general, everything you own yourself or through a Revocable Trust (addressed below) including IRAs and insurance policies. Many individuals are surprised to learn that the death benefit on a life insurance policy is includable in the insured’s estate if the insured owned the policy during his or her life. For example, if you have a $1 million term life insurance policy on your life, the $1 million that is payable upon your death is included in your estate and subject to estate tax at your death despite the fact that from your perspective the policy was likely a liability during your life.

Q: What are the income tax characteristics of an inheritance (i.e., assets received from someone’s estate)?

A: An inheritance is not included in the gross income of the heir. In general, the heir takes a carry-over basis in the inherited asset (although, in general, the basis is increased to the extent of estate tax paid, if any, with respect to the asset).

I don’t make gifts other than annual exclusion gifts, and I don’t expect that my estate will be subject to estate tax upon my death. Do I need a Will?

Yes, you need a Will in addition to other basic documents. In Arizona, there are four generally recommended estate planning documents: a pour over Will, Revocable Trust, Durable Power of Attorney and Health Care Power of Attorney / Living Will.

A Will is a written document that directs the distribution of an individual’s assets upon his or her death. A Will also nominates guardians for minor or incapacitated children. If an individual dies without a Will, any assets in the name of the individual that do not otherwise transfer by operation of law (e.g., by beneficiary designation or joint ownership) will be distributed to various family members according to the laws of intestacy. A Will is subject to probate. The individual making the Will may be amend or revoke it at any time for any or no reason.

A Revocable Trust is a legal arrangement where a Trustee (i.e., the person that administers the Revocable Trust) takes titled to assets previously titled in the name of the settlor (i.e., the person creating the Revocable Trust). The settlor and the Trustee is typically the same person. The terms of the trust agreement — the document that creates the Trust — govern who will serve as Trustee, and who gets what property when.

A Revocable Trust is a Will substitute; when one creates a Revocable Trust, typically one also creates a so-called “pour over” Will that directs than any assets not in the Revocable Trust at death be transferred to the Revocable Trust. The pour over Will also designates guardians for minor or incapacitated children.

A Durable Power of Attorney allows you to appoint one or more agents to act on your behalf with respect to your assets and other personal matters.

Health Care Power of Attorney / Living Will allows you to designate one or more agents to act on your behalf with respect to your health care. The document also allows you to make your wishes known with respect to end-of-life decisions including organ donation, autopsy and life support.

Q: What is probate?

A: Probate is the process by which a court supervises the distribution of a deceased individual’s assets. The court will appoint a Personal Representative (referred to in some jurisdictions as an “executor”) to administer the estate. Probate is public, and it can be time-consuming and expensive.

Q: How do I avoid probate?

A: There are several ways. The most common means is to create a Revocable Trust (i.e., a “living trust”) during your life.

There are many benefits to a Revocable Trust, including the ability to provide for the management of your assets in the event you are incapacitated or disabled, and to prevent beneficiaries from receiving assets at a young age or when they are troubled. A Revocable Trust can be amended or revoked for any or no reason at any time by the settlor. A Revocable Trust is a private arrangement; the trust agreement is not filed with any agency.

Q: Can I prepare my own Will, Revocable Trust, Durable Power of Attorney and a Health Care Power of Attorney / Living Will?

A: You should consult a qualified attorney on any estate planning matter including the preparation of such legal documents.

• Brian Foster is a 20-year Ahwatukee resident and senior partner at Snell & Wilmer L.L.P. in Phoenix. Reach him at (602) 382-6242 or bfoster@swlaw.com. Prescott Pohl, also a partner at Snell & Wilmer L.L.P, can be reached at (602) 382-6515.

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