Overview of Estate Planning Concepts
The Marital Deduction
Property passing from one spouse to another spouse who is a citizen of the United States, whether by (1) a lifetime gift, (2) provisions of a will, (3) joint title, or (4) beneficiary designation, will pass free of estate tax because such transfers qualify for the presently unlimited “marital deduction.”
The Applicable Exclusion Amount
The Federal “Applicable Exclusion Amount” allows an individual to leave up to a certain dollar amount to one or more persons, other than a spouse, without incurring a Federal estate tax liability. This figure is adjusted annually for inflation; in 2023 the exclusion is $12,920,000. The Federal estate tax rate is 40%.
Portability enables a married couple to easily utilize both of their exemptions, thereby enabling the couple to pass up to $25,840,000 to their heirs free of Federal estate tax.
The Applicable Exclusion Amounts vary from state to state. Many states, including Florida and New Jersey, have no separate estate tax, although New Jersey applies an "inheritance tax" on transfers to non-immediate family members. The New York exemption is now $6,580,000 and the Connecticut exemption is $9,100,000. Both of these exemptions will be increasing in future years.
Lifetime Exclusion from Gift Tax
The Federal tax law provides a gift tax “exemption” which offsets the tax on taxable lifetime gifts of up to $12,920,000.
Generation-Skipping Transfer Tax
The Internal Revenue Code penalizes transfers of property that "skip" a generation (i.e. pass from a grandparent to a grandchild without being taxed at the child's generation) by imposing an additional tax at a rate of 40%, referred to as the "generation-skipping transfer" ("GST") tax. In 2020, the Federal law allows for a maximum skip of up to $12,920,000 without triggering the GST tax.
Annual Gift Tax Exclusion
An individual may give $16,000 each calendar year to as many persons as he or she desires, free of Federal gift taxes. A married couple may also “pool” their gift tax exclusions, thus enabling them to make annual joint gifts of $32,000 to each of their children and any other person(s) they may choose. Even if the $32,000 consists entirely of the assets owned individually by one of the spouses, for gift tax purposes the gift will be treated as one-half by each spouse. Such a joint gift requires the filing of a Federal gift tax return even though no tax is due. The annual gift tax exclusion is adjusted annually for inflation.
Exclusion of Life Insurance Proceeds
Proceeds from life insurance policies are included in the estate of the insured, for estate tax purposes, if the insured is the owner of the policy or retains the power to change the beneficiary of the policy. To insulate proceeds of an insurance policy on an individual’s life from estate tax, an individual may assign ownership of the policy to the beneficiary, though preferably not a surviving spouse. Alternatively, the insured may create an irrevocable trust, over which he or she retains no control, which will “own” the policy. The person creating the trust, called the grantor, makes cash gifts to the trust periodically. The trustee uses these gifts, which qualify for the annual gift tax exclusion, to purchase and maintain the policy. To prevent “death bed transfers,” three years must pass from the date of assignment of the policy to the date of death for the insurance proceeds to be excluded from the taxable estate of the insured.