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2015 Gift Tax Updates

Effective January 1, 2015 there were updates to the gift and estate tax laws which were part of the American Taxpayer Relief Act of 2012, an act which brought an end to the uncertainty that had plagued the estate planning community in recent years. Illinois estate planning lawyers can now work to create an estate plan specifically tailored to their clients’ needs and desires without the burden of having to deal with legislative contingencies.

Overview of the new law

The 2012 Taxpayer Relief Act made permanent many estate, gift and GST tax provisions, including the ability to transfer any unused estate exemption amount between spouses (referred to as “portability”), that would have expired on December 31, 2012. The Act also increased the maximum estate, gift and GST tax rate to 40%.

Higher rate and higher exemption for 2015

For estates of individuals dying and gifts made in 2015, the top transfer tax rate is 40%. Before the 2012 Taxpayer Relief Act, the top rate was to rise to 55% for estates of individuals dying and gifts made after 2012.

Further, the 2012 Taxpayer Relief Act made permanent the $5 million exemption from 2011, adjusted annually for inflation, which is far more advantageous than the $1 million exemption that was expected to apply in the absence of new legislation. Even gifts that are not covered by the exclusion, and that are thus taxable, may not result in a tax liability. This is so because a tax credit wipes out the federal gift tax liability on the first taxable gifts that you make in your lifetime, up to $5,430,000 (for 2015). However, to the extent you use this credit against a gift tax liability, it reduces (or eliminates) the credit available for use against the federal estate tax at your death.

GST tax changes made permanent

The GST tax is an additional tax on gifts and bequests to grandchildren, when their parents are still alive, and other individuals who are 37.5 years younger than the transferor. The 2012 Taxpayer Relief Act prevented the GST exemption amount from returning to $1 million and a 55% tax rate, and instead, the Act provided that the GST tax exemption and tax rate follow the estate tax exemption (adjusted for inflation) and 40% rate.

Continuation of portability

The 2012 Tax Relief Act also made permanent the election for a surviving spouse to use any exemption that remains unused at the death of the first spouse, in addition to his or her own $5.43 million exemption (the exemption amount for 2015) for taxable transfers made during life or at death. If this portability feature had expired at the end of 2012 as was scheduled, the exemption of the first spouse to die would have been lost if not used, or if proper planning (such as the creation of a credit shelter trust) was not done. While this portability rule may make credit shelter trusts unnecessary in some cases, credit shelter trusts can be beneficial because they may shield some appreciation from estate tax and offer protection from creditors. Note that the transferred exemption may be lost if the surviving spouse remarries and is again widowed.

Annual Exclusion Gifts

Taxpayers can transfer substantial amounts free of gift taxes to their children or other donees through the proper use of the federal gift tax annual exclusion. The amount of the exclusion for 2015 remains at $14,000. The exclusion covers gifts an individual makes to each donee each year. Thus, for example, a taxpayer with three children can transfer a total of $42,000 to them every year free of federal gift taxes. If the only gifts made during a year are excluded in this fashion, there is no need to file a federal gift tax return. If annual gifts exceed $14,000, the exclusion covers the first $14,000 and only the excess is taxable. Furthermore, even taxable gifts may result in no gift tax liability thanks to gift-splitting between married taxpayers (discussed below). Note, this discussion is not relevant to gifts made by a donor to his spouse because these gifts are gift tax-free under separate marital deduction rules.

If the donee of a gift is a minor and the terms of the trust provide that the income and property may be spent by or for the minor before he reaches age 21, and that any amount left is to go to the minor at age 21, then the annual exclusion is available (that is, the present interest rule will not apply). These arrangements (called Code Sec. 2503(c) trusts because of the section in the Internal Revenue Code that permits them) allow parents to set assets aside for future distribution to their children while taking advantage of the annual exclusion in the year the trust is set up.

Gift-Splitting by Married Taxpayers

If the donor of the gift is married, gifts to donees made during a year can be treated as split between the husband and wife, even if the cash or gift property is actually given to a donee by only one of them. By gift-splitting, therefore, up to $28,000 a year can be transferred to each donee by a married couple because their two annual exclusions are available. Thus, for example, a married couple with three married children can transfer a total of $168,000 each year to their children and the children’s spouses ($28,000 for each of six donees).

Illinois Estate Tax

Illinois legislation has also made the Illinois Estate Tax permanent. Illinois has set the exclusion amount at $4 million for 2013 and future years (including 2015), at variable tax rates. Under Illinois law, the State Estate Tax does not contain a portability provision, therefore, a spouse’s unused exemption does not pass to the surviving spouse and is lost to the extent it is not fully utilized.

Illinois Estate Tax is a separate and distinct tax from the Federal Estate Tax. Tax is assessed on estates in which the decedent has a taxable estate in excess of $4 million. The tax rates are graduated tax rates, depending on the value of the taxable estate. Unlike the Federal Estate Tax, which calculates a 40% tax on the taxable estate in excess of the exemption amount, in Illinois, if the estate exceeds $4 million, then the tax is calculated at graduated rates on the entire estate (not just the taxable estate in excess of the $4 million exemption). Accordingly, the actual tax rate can be as high as 28% of the amount in excess of the Illinois exemption amount of $4 million.

The amount of Illinois tax is a deduction for Federal Estate Tax purposes, but is no longer a full credit. Accordingly, the combined Federal and Estate tax amounts are substantially higher than they have been in the past (when the Federal calculation allowed for a full tax credit).

Conclusion

In addition to the Illinois estate tax law changes, the 2012 Taxpayer Relief Act made many estate, gift and GST tax rules permanent by repealing the sunset language that was in place in previous legislation, and thereby eliminated the uncertainty as to what the state of transfer tax law would be beyond 2013.

Although benefits such as the large exemption amount and portability remain and protect significant assets from transfer tax, we should meet to discuss your estate plan to make sure we are taking full advantage of these rules that now have become permanent.

Please contact our office if you wish to discuss this area further or have questions about estate planning.

IRS Circular 230 Notice: To ensure compliance with requirements imposed by the IRS, we inform you that this written advice is not intended or written to be used, and it cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed on the taxpayer.