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LLOYD MARTIN PLC
9316 Old Keene Mill Road, Suite A
Burke, Virginia 22015-4285
Telephone: 703-584-7744
FAX: 703-584-7746
Email: lmartin@pwtitle.com
Some notes on estate-tax planning
The Federal Estate Tax
The Estate Tax is a tax on your right to transfer property at your death. It consists of an accounting of everything you own or have certain interests in at the date of death. The fair market value of these items is used, not necessarily what you paid for them or what their values were when you acquired them. The total of all of these items is your "Gross Estate." The property included in the Gross Estate may consist of cash and securities, real estate, insurance, trusts, annuities, business interests and other assets.
Once you have accounted for the Gross Estate, certain deductions (and in special circumstances, reductions to value) are allowed in arriving at your "Taxable Estate." These deductions may include mortgages and other debts, estate administration expenses, property that passes to surviving spouses and qualified charities. The value of some operating business interests or farms may be reduced for estates that qualify.
After the net amount is computed, the value of lifetime taxable gifts (beginning with gifts made in 1977) is added to this number and the tax is computed. The tax is then reduced by the available unified credit. Gifts which are within the annual gift-tax exclusion level of $17,000 per donee are not counted as part of the lifetime gifts.
Most relatively simple estates (cash, publicly traded securities, small amounts of other easily valued assets, and no special deductions or elections, or jointly held property) do not require the filing of an estate tax return. A filing is required for estates with combined gross assets and prior taxable gifts exceeding $1,500,000 in 2004 - 2005; $2,000,000 in 2006 - 2008; $3,500,000 for decedents dying in 2009; and $5,000,000 or more for decedent's dying in 2010 and 2011 (note: there are special rules for decedents dying in 2010); $5,120,000 in 2012, $5,250,000 in 2013, $5,340,000 in 2014, $5,430,000 in 2015, $5,450,000.00 in 2016, $5,490,000.00 in 2017, $5,600,000.00 in 2018, $11,400,000.00 in 2019, $11,580,000.00 in 2020, $11,700,000.00 in 2021, in 2022, $12,006,000.00 and in 2023, 12,920,000.00. However, this amount is set to revert to the pre-2018 level of $5 million, adjusted for inflation, in 2026 when the Tax Cuts and Jobs Act (enacted in November 2017) expires.
Beginning January 1, 2011, estates of decedents survived by a spouse may elect to pass any of the decedent’s unused exemption to the surviving spouse. This election is made on a timely filed estate tax return for the decedent with a surviving spouse. Note that simplified valuation provisions apply for those estates without a filing requirement absent the portability election.
For additional information, refer to IRS Instruction for Form 706.
Real Estate and Capital Gains Taxes
The biggest tax concern when selling real property is capital gains tax. A capital gain is the difference between the “basis” in property and its selling price. The basis is usually the purchase price of property. So, if you purchased a house for $250,000 and sold it for $450,000, you would have $200,000 of gain ($450,000 - $250,000 = $200,000).
Couples who are married and file taxes jointly can sell their primary residence and exclude up to $500,000 of the gain from the sale from their gross income. Single individuals can exclude only $250,000. Surviving spouses get the full $500,000 exclusion if they sell their house within two years of the date of the spouse’s death, and if other ownership and use requirements have been met. The result is that widows or widowers who sell within two years may not have to pay any capital gains tax on the sale of the home.
Step-Up in Basis
When a real estate owner dies, the cost basis of the real property is "stepped up." This means the current value of the property becomes the basis. When a joint owner dies, half of the value of the property is stepped up. For example, suppose a husband and wife buy real estate they use as their primary resident, for $200,000, and then the husband dies when the property has a fair market value of $300,000. The new cost basis of the property for the wife will be $250,000 ($100,000 for the wife’s original 50 percent interest and $150,000 for the other half passed to her at the husband's death).
Virginia Estate Taxes
Although this discussion is limited to the federal estate tax, it is appropriate for us to include a brief comment about Virginia estate taxes.
Virginia does not currently collect a state estate tax, although things were different a few years ago before major changes took effect with regard to federal estate tax laws. Prior to January 1, 2005, Virginia, like many other states, collected a separate state estate tax, called a "pick up tax," that was actually equal to a portion of the overall federal estate tax bill.
A "pick up tax" or sometimes called "sponge tax" is a state estate tax that is collected based on the maximum state estate tax credit that the IRS will allow on the federal estate tax return. The overall estate tax bill is neither increased nor decreased due to the pick up tax, instead the tax bill is apportioned between the IRS and an appropriate state taxing authority.
On January 1, 2005, the pick up tax was officially phased out and the Virginia legislature enacted a short lived state estate tax that was imposed for deaths occurring between January 1, 2005, and June 30, 2007, but ending for deaths occurring on or after July 1, 2007; however, the Virginia pick up tax was scheduled to return at the end of 2011, along with the expiration of the Bush tax cuts. The Virginia General Assembly followed the lead of President Obama and the Congress with the passage of the 2010 Act and subsequent legislation, with similar state legislation so that Virginia will not collect a state estate tax for the 2011 and subsequent years.
The Credit Shelter Trust
One of the most common and most effective methods of minimizing the estate tax bite is through the use of a credit shelter trust, sometimes referred to as a bypass trust. The credit shelter trust is intended to allow married couples to take full advantage of the lifetime exemption from estate taxes and minimize federal tax on their combined estates. This trust allows each individual to use his or her lifetime exemption from estate taxes.
The lifetime exemption is calculated as a credit against the estate and gift tax and is sufficient to offset the tax due on an estate up to a specific size, as outlined above. The 2023 individual exemption amount is $12,920,000, therefore a married couple in 2023 has a combined exemption of $25,840,000. The credit shelter trust is suitable for those couples where either spouse has an individual estate which exceeds the exclusion level or couples who have combined assets that exceed their combined exclusion amount of $25,840,000 in 2023 (these figures will change annually based upon CPI adjustments, to which the credit level is indexed).
How Does the Credit Shelter Trust Work?
As a general rule, the credit shelter trust is funded with assets that are adequate, and are intended to, fully utilize the individual decedent’s federal estate tax exclusion amount as outlined above, and is designed to apply to the estate of the first spouse to die. The trust may be funded either during one’s lifetimes through a living trust and gifts to the trust, or at the time of the death of the first spouse using a testamentary trust (i.e., one which is specified within a will and not actually funded or created until the will is probated).
Under the credit shelter trust, a surviving spouse may be given restrictive access and control over the assets in the trust or it can be set up to give the surviving spouse all the annual income that is earned by the trust, with the added authorization to withdraw up to $5,000 or five percent of the corpus of the trust for any reason that he or she sees fit or to use the trusts’ principal when necessary for health, support, education, or maintenance purposes.
The essence of the credit shelter trust, however, is that the ownership of the corpus of the trust actually passes to beneficiaries other than one’s spouse, such as the couple’s children, when an asset placed in the trust. The surviving spouse receives limited benefit from the trust during his or her lifetime. Upon the death of the second spouse, the trust generally passes in total to the beneficiaries according to such other terms as may be included in the trust agreement.
Conclusion
Many couples fail to realize the true worth of their estate and thus do not properly plan their estates to minimize or avoid the potential estate tax bite to which the individual or combined estates could be subjected. Factor in proceeds from life insurance policies, primary and secondary residences and real estate investments, as well as other assets, the combined marital estate could surprisingly reach or surpass the current individual exclusion amount of $12,920,000.
Although the credit shelter trust is a common estate planning tool, there a number of relatively easy steps a couple or an individual can take which will reduce the size of a combined or individual estate and thus avoid or minimize any potential estate tax bite. For example, life insurance could be paid through a life insurance trust which transfers ownership of the policy, and thus removes the death benefit proceeds from the estate of the decedent.
A couple or an individual could also make maximum use of an annual gift giving program, making gifts to others up to the exemption amount of $17,000 per year. Keep in mind that this amount applies per gift per individual. So, a married couple may each gift $34,000 to the same person annually. That is a combined gift of $17,000 each, all of which would thereafter be removed from the couple’s estate and not subject to any estate taxes and not require filing of a gift tax return.
Talk with an estate planner and your financial consultant to find out if there are steps you should take to address any estate tax issue you may face and see whether a credit shelter trust, or some other planning technique may be right for your financial future. In any event, pay attention on both the federal and the state level for legislative changes which could impact on estate and give tax exclusion levels which could affect your planning.
The rising federal estate tax exemption in recent years means that many older trusts drawn up for married couples contain outdated credit-shelter trusts with estate-splitting provisions that may cost them dearly in state or federal taxes, or both. Couples would do well to have their wills and/or revocable trusts that contain credit shelter provisions reviewed by a competent professional.
Finally, even though Virginia has no estate or inheritance tax, there are other reasons to have a credit shelter trust, including the following:
- It shields funds in trust from creditors
- It protects children’s inheritance if the surviving spouse remarries
- It helps avoid administrative headaches
- Congress can decide to change the estate tax
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We pride ourselves on the quality and excellence of our service to our customers and clients. However, we are not perfect, so if we do not give you the service you expect, in both a timely and cost-effective manner, tell us. We also believe that our competitive prices always give you value for your dollar. Please tell us if you disagree!
LLOYD MARTIN PLC is a professional limited liability company. Our practice emphasizes real estate closings, real estate law, and related matters. The firm also provides legal services to small businesses and to clients in the areas of trusts and estates. We bring to our clients and prospective clients over two decades of real estate experience in Northern Virginia. We have also served the legal needs of our trust and estate and small business clients in the City of Alexandria and Arlington, Fairfax and Prince William Counties and surrounding areas since 1984.
The information contained herein is furnished by LLOYD MARTIN PLC for clients and prospective clients. Readers should not attempt to solve legal problems based on information contained herein, it being of general interest only.
Required Disclaimer Under IRS Circular 230: Internal Revenue Service regulations require us to notify the recipient that any U.S. Federal tax advice provided in this communication is not intended or written to be used, and it cannot be used by the recipient or any other taxpayer (i) for the purpose of avoiding tax penalties that may be imposed on the recipient or any other taxpayer, or (ii) in promoting, marketing or recommending to another party a partnership or other entity, investment plan, arrangement or other transaction addressed herein.
NOTE: Some of the information on this page was either copied or adapted from the IRS web page on Estate Tax.