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Estate Planning 101 - Important Terms to Remember

February 07, 2022

When it comes to estate planning, there are a lot of acronyms and form numbers to remember. Here is a refresher for you.

Gift and Estate Tax Refresher

From 30,000 feet, the gift tax and the estate tax are effectively treated as one tax. The gift tax is a tax paid during your lifetime on taxable gifts more than your Lifetime Exclusion. The Estate tax is a tax paid on your remaining assets in excess of the Lifetime Exclusion.

Current federal law provides for a lifetime estate and gift tax exclusion amount (“Lifetime Exclusion”), which is the amount of assets an individual can give away during life before incurring a gift tax or, to the extent not used during life, the amount of estate assets which may be sheltered from estate tax at death. Currently the Lifetime Exclusion amount is $12,060,000 per person. Gifts or estate assets exceeding your Lifetime Exclusion get very quickly to a 40% tax rate.

Transfers between spouses (either during life or at death) are effectively tax-free and do not reduce the transferor’s Lifetime Exclusion. In addition to the Lifetime Exclusion, every individual may make gifts of up to $16,000 per year to as many recipients as they choose. These gifts (referred to as annual exclusion gifts) do not count against the donor’s Lifetime Exclusion.

Portions of the federal gift, estate and GST tax laws are scheduled to expire at the end of 2025. At that time the Lifetime Exclusion and the GST Exemption will be reduced to $5,000,000 per person, indexed for inflation. If an individual’s lifetime gifts exceed the amounts of Lifetime Exclusion or GST Exemption existing in the year of death, such lifetime gifts generally will not be “clawed back” into the person’s taxable estate due to a change in the tax law. So, use your Lifetime Exclusion and GST Exemption before 2026 and you can lock in the current amounts, even if those amounts are subsequently reduced by changes in tax law. But there is no guarantee that Congress could not apply a change in tax laws retroactively.

What does it mean to “File a 709”?

How many times have you heard your estate attorney or CPA say, just “File a 709.” Let’s quickly talk about the 709, the Annual Gift Tax Return. There is a lot of confusion about this. Do I have to pay a tax? Does the donee pay a tax? Is it tax deductible, or is it taxable income?

These questions are best answered by an example.

Say Maurice gives me $116,000 this year, 2022. Maurice must file a 2022 Form 709, U.S. Gift tax return, by April 15, 2023, or the extended due date.

The 709 will reflect that he gave me $116,000 during 2022. The form will reduce the actual gift by the $16,000 annual per donee exclusion, up from $15,000 in 2021, and reflect that Maurice made a taxable gift in 2022 of $100,000. Through a few gyrations, the Form will then take Maurice’s Lifetime Exclusion of $12,060,000 and subtract from it the $100,000 of taxable gifts in 2022. The result, $11,960,000, is Maurice’s Unused Lifetime Exclusion at the end of 2022. No tax is owed on a gift tax return until Maurice’s total Unused Lifetime taxable gifts exceed $12,060,000.

Generation-Skipping Transfer (GST) Tax Overview

In addition to the gift and estate taxes, the federal tax code imposes a “generation-skipping transfer (GST) tax” on transfers made to individuals two or more generations below the donor (referred to as skip persons). Every individual is afforded a GST exemption (“GST Exemption”), analogous to the Lifetime Exclusion, which allows an individual to transfer a certain amount of assets to skip persons without incurring a GST tax. Under current law, the GST exemption is $12,060,000. Gifts or estate assets passing to skip persons more than the transferor’s GST Exemption are taxed at 40%.

Typically, a Trust is utilized for these transfers to future generations. GST Exemption can be allocated to a trust, creating what is commonly referred to as a “GST Exempt” trust. Distributions from a GST Exempt Trust, even to skip persons, will avoid the GST tax. Any appreciation on assets in a GST Exempt trust will also be exempt from the GST tax. Such trusts can be used to provide a source of funds for grandchildren and other descendants and remains sheltered from the estate, gift and GST taxes for as long as property remains in the trust.

Intentionally Defective Grantor Trusts (“IDGTs”)

Irrevocable trusts are an important tool for estate planning. A “Grantor” transfers assets into trust for the benefit of family members, such as the Grantor’s spouse, children and descendants. The transfer constitutes a taxable gift, but, if it does not exceed the available Lifetime Exclusion, $12,060,000, we all know now that there is no gift tax due. The trust assets (including appreciation on such assets) are removed from the Grantor’s estate and sheltered from estate tax at death.

It is common to setup an irrevocable trust as an Intentionally Defective Grantor Trust (“IDGT”). An IDGT causes the Grantor to remain liable for any income taxes generated by trust assets, while placing trust assets outside of the Grantor’s taxable estate. By using “your money” to pay the income taxes attributable to the income earned by the trust’s assets, you effectively allow the IDGT to grow income-tax free, you pay the taxes, while simultaneously reducing your taxable estate, by the income taxes you paid for the trust!

Stay tuned for more blogs on SLATs, FLPs and QPRTs.

Questions? Contact us.

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