Estate Tax: Will Your Family Have to Pay?
The first estate tax was imposed in 1797 to help fund a war against France. The estate tax became a permanent fixture in our tax system after World War I. The estate tax is a tax on real estate, stock, cash, and other assets transferred from deceased persons to their heirs. Will your children or heirs have to pay taxes on the house and other assets that you are leaving to them? If your children have to pay, the current estate tax rate is a whopping 40% PLUS applicable capital gains tax rate between 15% to 20%!
If you died in 1995, the amount passing free of estate tax was only $600,000. That estate tax exemption amount has risen from year to year. For example: in year 2000, it was $675,000; in year 2004, it was $1,500,000 and in year 2007, the federal estate tax exemption was $2,000,000. Then in January 2, 2013, President Obama signed into law the American Taxpayer Relief Act (known as ATRA), that sets the federal estate tax exemption amount to $5 million per person that is adjusted for inflation every year; thus, the federal exemption amount in 2015 is $5,430,000. If you die with less than $5,430,000 in assets, your children will not have to pay any estate tax. Furthermore, ATRA brought along a fantastic gift known as "Portability". "Portability" allows a surviving spouse to use the deceased spouse’s $5,430,000. Therefore, a married couple with assets less than nearly $11 million dollars will not have to pay a penny in estate tax.
ATRA changed the game in how a living trust should be structured. The living trust had been a significant estate planning tool for many years prior to 2013 for families to escape estate taxes. Therefore, if your living trust was prepared prior to 2013, you should revise your trust because, more likely than not, your trust was built to escape the estate tax and may have conceded to another tax known as the capital gain taxes. Prior to 2013, most trusts were "AB" trusts. An "AB" Trust provides that upon the death of the first spouse, the trust would be split into an "A" trust and "B" trust. One half of the assets would be in the "A" trust for the surviving spouse and the other half would be in the "B" trust that represents the deceased spouse’s half. This was a very common structure that was set up to escape the estate tax because the estate tax exemption amount ($600,000 in 1995) was very low prior to 2013. This "AB" Trust setup accomplished minimizing some estate tax but imposed a completely unnecessary capital gains tax penalty on the children or heirs of the estate. Therefore, after 2013 with the new ATRA tax law, 99.9 percent of the population simply will not have more than $11 million in their estate upon death to pay any estate tax. Thus, to keep the old "AB" Trust that was created prior to the new ATRA tax law might be detrimental in terms of imposing an unnecessary capital tax gains on your children because under the old "AB" Trust there is no "double step-up in basis". The "AB" Trust does not allow for a "double step-up in basis". The "double step-up in basis" refers to the two increases in basis to which your children would be entitled if your house pass (1) from the deceased spouse to the surviving spouse, then (2) from the surviving spouse’s death to the children. For example, you and your spouse, bought a house for $50,000. Twenty years later, the house is worth $500,000 and the husband died but the wife continues to live another 25 years. The "AB" Trust would split the house value into two halves and in essence freeze the cost basis at the time of the deceased husband and then the children cost basis in dad’s half would be whatever the value it was at dad’s death. When mom dies 25 years after dad’s death, the children will receive the mom’s half and cost basis would be the market value at mom’s death. Thus, if there were no "AB" Trust because with ATRA there is no concern for estate tax, the entire house would pass to mom at time of dad’s death and when mom dies the house is worth $1 million, the children would get a "double step-up in basis" to $1 million. When the children sell the house for $1 million with a cost basis of $1 million, the children would pay ZERO capital tax gain! There may be some legitimate reasons for an "AB" Trust (e.g., separate children from prior marriages).
In conclusion: if you have a trust that was prepared prior to 2013, it would be best to consult an estate planning attorney because of the new tax law changes and quite possibly you may have major changes in your life. Please feel to call me at 626-695-7310 with any questions. I handle probate, living trust and bankruptcy cases.