The Federal Gift and Estate Tax System is a unified system of taxation on gifts during life and at death. The gross estate “shall include the value of all property to the extent of the interest therein of the decedent at the time of death.” For taxable estates, the estate tax return is due 9 months after the date of death. The return deadline may be extended for not more than 6 months. If the estate is less than the applicable federal exemption, an estate tax return does not have to be filed. However, to preserve the portability of a spouse’s applicable exemption amount (estate tax credit) a timely return should be filed. Consult with a qualified estate planning attorney to determine whether an estate tax return should be filed.

The federal estate tax rates are progressive; therefore, larger estates are subject to higher tax rates than smaller estates. The tax applies to asset transfers during life as well as to all of the assets owned at death. The proper use of estate planning techniques can reduce or eliminate estate taxes.

The following information is from John’s book, Louisiana Retirement and Estate Planning. To order a copy of his book, click here.

Assets Included in the Gross Estate

Many people are confused as to which assets must be included in the gross estate. This is why underestimating the value of the gross estate is a common tax trap. The federal gross estate is more expansive than the Louisiana probate estate as it includes the value of all of the assets the decedent had an interest in at the time of death. Interests in assets such as life insurance and retirement plans must be included in the federal gross estate although they are excluded from the Louisiana probate estate. If the estate is the beneficiary of life insurance and retirement plans, however, these assets are included in the Louisiana probate estate and are governed by the decedent’s will. A common misconception is that life insurance is not taxable. Although life insurance is generally not subject to income taxation, the death benefit is generally subject to estate taxation. In addition to the assets owned at death, the following property interests are included in the gross estate:

1. Property transferred with “strings attached”. If you transfer property and retain control over the property, it will be included in your estate. For example if the trustee of an irrevocable trust has too much control and discretion over the trust assets and these assets may be freely used by the trustee, the trust assets may be included in the trustee’s estate.
2. The value of an annuity receivable by a beneficiary which was payable for a set number of years or over the life expectancy of the decedent. For example if the decedent was receiving a pension payment that will continue for the surviving spouse, the value of the remaining payments to the surviving spouse is included in the federal gross estate.
3. The value of property held as Joint Tenants With Rights of Survivorship (JTWOS) Legal services are not provided in the capacity as a registered representative of Raymond James Financial Service, Inc. (Raymond James), or any of its affiliates. Neither Raymond James nor any of its affiliates recommend, have reviewed or approved the product/service. Further, Raymond James has not conducted any due diligence regarding this product/service. I am not relying on Raymond James or its affiliates to pass upon the suitability or appropriateness of said product/service. Raymond James is not responsible for supervising any activity pertaining to the below product/service., except to the extent the surviving joint tenant can be shown to have contributed to the acquisition of the property. As Louisiana does not recognize JTWOS, this will apply to immovable property outside of Louisiana.
4. Life insurance proceeds paid to the estate.
5. Life insurance proceeds in which the decedent had incidents of ownership.
6. The Three-Year Rule. IRC § 2035 includes in the gross estate certain property transferred within three years of death.

The Three-Year Rule includes the life insurance death benefit on the decedent’s life transferred within three years of death. The decedent must relinquish all “incidents of ownership” at least three years prior to death to exclude the death benefit from the decedent’s estate.

Federal Estate and Gift Tax Credit (Federal Estate Tax Exclusion)

The Applicable Exclusion Amount (Lifetime Exemption)

In addition to the gift tax annual exclusion, everyone has a lifetime exemption amount which may be used during life or at death to offset estate and gift taxes. There has been much debate and speculation regarding the future of the estate tax and exemption levels and the future landscape is uncertain. As of 2016, each person has a $5,450,000 federal estate tax exemption. Technically the estate tax exemption is referred to as the applicable exclusion amount (aka credit shelter amount, federal tax exemption amount, lifetime exemption amount). Property passing to anyone other than the surviving spouse may be applied to the applicable exclusion amount.

Thus, a donor making a gift valued over $14,000 in 2016 may elect not to pay taxes on the amount over $14,000, but may use their lifetime exemption amount to offset the gift taxes. Any amount of the exemption used during the decedent’s lifetime reduces the exemption amount available at death.

For Example, if Boudreaux and Clotile make a donation of community property real estate worth $100,000 to their son, $28,000 will be exempt from gift taxes due to Boudreaux and Clotile’s annual exclusion. They may pay gift taxes on the remaining $72,000, or they may use a portion of their lifetime federal estate tax exemption amount to prevent gift taxes on the transfer. The gift tax form 709 must be filed for this donation because the value of the donation is greater than the annual exclusion. Form 709 also documents the use of the federal estate tax exemption amount in lieu of paying gift taxes on the donation.

Portability of the Applicable Exclusion Amount

The 2010 Tax Relief Act allows portability of the applicable exclusion amount by providing that the applicable exclusion amount is the basic exclusion amount plus the deceased spousal unused exclusion amount. Portability of the applicable exemption amount applies to the estate of decedents dying and gifts and generation skipping transfers made after 2010. In 2016, the basic exclusion amount is $5,450,000. The deceased spousal unused exclusion amount is the lesser of (1) the basic exclusion amount, or (2) the excess of the basic exclusion amount of the last such deceased spouse, or such surviving spouse, over the amount with respect to which the tentative tax is determined under Internal Revenue Code §2001(b)(1) on the estate of such deceased spouse.

Portability only applies if the executor of the estate of the deceased files an estate tax return.

The Marital Deduction

The Unlimited Marital Deduction allows spouses to transfer an unlimited amount of assets between each other either inter-vivos or at death free of gift taxes. The marital deduction automatically applies to assets transferred to the surviving spouse. The donor’s spouse must be given either full ownership of the property or a qualified terminal interest. A lifetime usufruct is a qualified terminal interest (QTIP Property). To use the marital deduction, the spouse must also be a United States citizen. If the surviving spouse is not a United States citizen, a Qualified Domestic Trust (QDOT) may be used to preserve the marital deduction.

Many estate plans provide a bequest of all of the decedent’s assets to the surviving spouse. This strategy works well for combined estates valued under or near the applicable exemption amount. If the spouses’ combined estate value is greater than the applicable exemption amount, leaving everything to each other can result in unnecessary estate taxes. Over-funding the marital deduction by leaving everything to the surviving spouse can result in the decedent spouse’s applicable estate tax exemption amount to go unused because the marital deduction is applied prior to the estate tax exemption amount. Over use of the marital deduction may leave no assets left which to apply the estate tax exemption amount. Portability of predeceasing spouse’s applicable exemption amount to the surviving spouse can help avoid estate taxes upon the surviving spouse’s death.

Assets passing to anyone other than the surviving spouse will not fall under the marital deduction unless the asset is Qualified Terminal Interest Property (QTIP). To qualify for QTIP treatment all income must be paid to the surviving spouse at least annually, and the spouse must have the right to demand non-income producing assets be converted into income producing assets. The executor must make the QTIP election on Form 706. The election is irrevocable.

Transferring the naked ownership of assets to the children and the usufruct for life to the surviving spouse will enable the executor to select QTIP treatment for certain assets on an asset by asset basis. Assets that are not QTIPed are included in the first to die spouse’s estate and are offset by the applicable estate tax exemption amount. Assets that are QTIPed will qualify for the marital deduction and will be included in the second to die spouse’s estate.

This election allows post death planning, and it allows the testator to use a wait and see approach. If the deceased spouse’s estate is less than the exemption amount and there is little or no possibility that the combined estates of both spouses will exceed the federal estate tax exemption, all of the assets may be left to the surviving spouse outright. If usufruct is used, the QTIP election need not be made in this case. If the estate is small enough, it is irrelevant if the first-to-die spouse’s estate tax exemption is wasted or if both spouse’s exemptions are underutilized. However, if the combined estates will exceed or have the potential to exceed the federal estate tax exemption, the exemption of each spouse should be used to reduce or eliminate estate taxes. In this case, use the first-to-die spouse’s federal estate tax exemption by leaving assets to someone other than the surviving spouse, funding a credit shelter trust, or not electing the QTIP election for assets over which the spouse has usufruct. These assets will use the first-to-die spouse’s federal estate tax exemption. On the other hand, assets left outright to the surviving spouse or usufruct assets for which QTIP treatment is selected will be included in the surviving spouse’s estate and fall under the surviving spouse’s federal exemption amount.

Marital deduction and credit shelter planning are often accomplished with trusts such as the credit shelter trust and QTIP trust. The key point is to structure the estate plan to optimize the use of the federal estate tax exemption of each spouse.

Contact Jefferson attorney John E. Sirois at 985-580-2520 if you have questions about estate and gift taxation. Click on the Estate Planning Checklist to begin planning your estate. You may also e-mail him for a consultation.

Gift Taxation

The Internal Revenue Code imposes a gift tax on transfers of assets by gift. Gift taxes prevent transferring assets out of an estate to avoid the estate tax. Donative intent of the donor is irrelevant for gift tax purposes. So if it “looks” like a gift, the donor cannot claim the transfer was not intended as a gift if the donee has total dominion and control over the asset. Any transfer for less than adequate consideration is a gift subject to taxation. This means that if an asset is sold for significantly less than fair market value it will be treated as part sale and part gift. The gift tax applies to direct or indirect transfers and transfers in trust of all types of property. A gift is complete when the donor has parted with dominion and control with no power over its disposition.

The donor (person gifting) is responsible for any gift taxes due. In the event that the donor does not pay the gift taxes due, the donee is liable for the taxes due. A gift tax return must be filed by April 15 of the year after the transfer was made. For gifts made after December 31, 1996, the donor must provide disclosure “adequate to apprise the Internal Revenue Service of the nature of the gift and the basis for the value reported.” Adequate disclosure starts the running of the three year statute of limitations. Without adequate disclosure, the IRS may attempt to revalue a gift at any time in the future. This means that many years after the transfer was made the IRS can decide to value the assets donated. If a donor makes a gift in the amount of the applicable annual exclusion for the year and if the Service determines that the gift was worth more than the annual exclusion of that year, either gift taxes will have to be paid or a portion of the applicable federal estate tax exclusion will have to be used.

Adequate disclosure includes:

1. 1. The identity and relationship between transferor and transferee.
2. 2. Description of the transferred property and consideration received.
3. 3. If property is transferred in trust, the trust’s TIN and a description of the trust terms.
4. 4. A detailed description of the method used to determine FMV of the transferred property or an appraisal by a qualified appraiser.
5. 5. A statement explaining any position that is contrary to any proposed, temporary or final Treasury Regulation or Revenue Ruling.

Incomplete transfers result from a reservation of powers or “strings attached” to the gift. If the donor reserves the powers to vest the corpus in the donor or to change beneficiaries, this results in an incomplete gift. Terminating the power or “strings attached” other than by the donor’s death results in a completed gift. If the Donor’s intention is to make a gift of assets for estate planning purposes all control and ownership of the asset must be relinquished.

Even a completed gift may be included in the donor’s estate. Transfers of assets over which the donor retained the possession or right to income or enjoyment, or the right to designate who will enjoy or possess the property either for life or a period that cannot be ascertained without reference to death, or for a period that does end prior to death is included in the donor’s estate. This means that the value of assets over which the donor retains an income interest for life or lifetime usufruct will be included in the donor’s estate.

Transfers Excluded From Gift Taxation

The Annual Exclusion

The annual exclusion allows gifts of present interests of up to $14,000 annually to each donee. Gift amounts greater than the annual exclusion ($14,000 in 2016) or gifts that are not present interests are taxable gifts. The annual exclusion amount is indexed for inflation but only increases in $1,000 increments.

Minor’s Trusts

A gift to a minor may be placed in trust with broad discretion given to the trustee as to distributions until the donee (the trust beneficiary) reaches age 21. These arrangements are called minor’s trusts or Section 2503(c) trusts. Transfers to individuals under the age of 21 are considered present interest gifts (qualifies for the annual exclusion) if the property and the income derived from it may be expended by or for the benefit of the person prior to age 21 and to the extent not expended is transferred to the person at age 21. An example of this type of gift is a minor’s trust where assets are transferred to the trust via annual exclusions. The trust holds the assets for the benefit of the minor subject to income and principal distribution requirements.

Tuition and Medical Expenses

Another great tax-efficient wealth transfer idea is to pay for a child or grandchild’s school tuition or medical expenses. Payment of tuition or medical expenses for the benefit of any person paid directly to the institution is not subject to gift tax.

A spouse may make annual donations of property valued at $28,000 (2016) if the gift is community property. A donor gifting community property valued at $28,000 or less does not have to file a gift tax return. If the spouses donate separate property worth more than the annual exclusion, they may treat the donation as a split gift. In this case a gift tax return must be filed to document the use of each spouse’s annual exclusion for the gift.

Louisiana Gift Taxes

The State of Louisiana has eliminated gift taxes for gifts made on or after July 1, 2008.

Louisiana Inheritance Taxes

Effective January 1, 2012, no inheritance taxes are due and no inheritance tax returns need be filed regardless of the date of death.

Tax Basis of Gifted Assets

When a donation is made, the donee generally takes the donor’s tax basis. However, when computing a loss on a subsequent sale of donated property, if the value of the property is less than the donor’s basis, the donee’s basis is the value of the property on the date of gift. In addition, when federal gift taxes are paid on the gift, the basis is increased by the portion of gift tax attributable to the increase in value of the property since it acquired that basis.

When property is inherited, the property received from a decedent takes a tax basis equal to the fair market value of the property on the date of death. The surviving spouse’s half of the community receives a step up in basis equal to the date of death fair market value.

Income in respect of a decedent (IRD) does not qualify for a step up in basis. An asset consisting of taxable income property that would have been taxable to the decedent had she lived to receive it and was not taxable while she was alive is IRD. It is taxable to the estate, beneficiary, legatee or heir when received. This applies to IRAs, qualified retirement plans, and annuities. For example, assets held in an IRA will not receive a step up in basis at the death of the IRA owner. The IRA beneficiary will have the same cost basis as the deceased IRA owner.

Contact lawyer John E. Sirois in Metairie at 985-580-2520 if you have questions about community property or planning your estate. Click on the Estate Planning Checklist to begin planning your estate. You may also e-mail him for a consultation.