Brady,
Morton,PLLC
4141 Parklake Avenue
Raleigh, NC 27612
Phone: 919-782-3500
Fax: 919-573-1430
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MEMORANDUM TO OUR CLIENTS AND FRIENDS ABOUT ESTATE AND GIFT TAXES R. DANIEL
BRADY, ATTORNEY
By Brady Morton, PLLC.
Board Certified Specialists in Estate Planning and Probate Law
A number of important changes have been made in the past several years in estate
and gift taxation. This memorandum summarizes the pertinent Estate and Gift Tax
provisions as they affect estate planning.
1. THE MARITAL DEDUCTION: The Internal Revenue code ("IRC") and North
Carolina grant an unlimited gift and estate tax deduction for all transfers to a
spouse whether made during life or death. Thus, any one may give or leave his or
her entire estate to the surviving spouse without gift or estate taxes.
The following qualify for the marital deduction: Outright gifts and bequests,
jointly-held property, life insurance, joint and survivor annuities, certain
life estates in real estate, and trusts of which the surviving spouse is sole
income beneficiary for life.
2. MARITAL DEDUCTION ("Q-TIP") TRUST: The IRC and North Carolina permit a
marital deduction in the estate of the first spouse to die, for a trust which
provides for all income to the surviving spouse for life. Upon his or her death
the balance in the trust will pass to the person or persons named in the trust
clause. This kind of trust - called a "Q-TIP" - may be used to prevent a
diversion of assets from the decedent's family, such as may occur upon a
remarriage of the surviving spouse. It is particularly helpful in second
marriage situations with combined families.
An additional feature of the Q-TIP Trust is that it enables the executor to
elect to qualify all or a portion of the trust for the marital deduction,
thereby allowing flexibility in post-death planning. In particular, sometimes it
is desirable to qualify only a portion of a Q-TIP trust for the marital
deduction, thereby permitting part of the estate to be subject to Federal and
North Carolina estate taxes. This may prove desirable in order to achieve a
degree of equalization of estate taxes on each estate so that the overall amount
of estate taxes payable by the estates of both spouses is kept to a bare
minimum.
3. THE CREDIT SHELTER TRUST: Substantial estate tax benefits can usually
be obtained by combining the use of the marital deduction with a trust of the
amount of property that can pass free of Federal estate tax in the estate of the
first spouse to die. A trust (a "credit shelter trust") of this maximum amount
in the first estate will be sheltered from Federal and North Carolina estate and
inheritance taxes in the estate of the surviving spouse. This trust is most
often either a family trust (for the benefit of all family members), or a
marital trust (for the sole benefit of the surviving spouse). The balance of the
first estate over the amount of the credit shelter trust can pass tax-free to
the spouse under the marital deduction, either outright or in trust. All Federal
taxes are avoided in the first estate, and the property in the credit shelter
trust escapes taxation in the survivor's estate. The credit shelter amount can
also be passed outside a trust by direct transfer to other family members if
that is an appropriate step to take in the overall plan.
Thus, when the credit shelter trust and the surviving spouse's exemption are
combined, a maximum of approximately $2.0 million in 2003 can pass through both
estates free of Federal estate taxes. The combined amount increases as a
result of the 2001 federal legislation as follows: 2005=$3.0 million; 2006,
2007 and 2008=$4.0 million; and 2009=$7.0 million.
A note of caution about credit shelter trusts: A credit shelter trust can only
be funded by property held in the individual name of the decedent; it is not
generally available where property is jointly-held since this property passes
automatically to the survivor. And jointly-held property between spouses will
not be available to fund the unified credit, because the value of the property
which passes to the surviving spouse automatically qualifies for the marital
deduction.
4. CHARITABLE DEDUCTIONS: All outright bequests to churches, synagogues
and other qualified charities are deductible for estate tax purposes. The value
of trust principal which is given to charity following the death of the income
beneficiary - usually a family member - is also partially deductible if the
trust is properly drafted. Other trusts paying "income" to charity with the
assets going to a family member at the termination of the trust generate
significant charitable deductions. People who have supported charities during
their lifetime may wish to consider charitable gifts in their Will as long as
the security of the family is not affected.
5. DISCLAIMERS: Where appropriate, provision may be made in a Will which
anticipates a disclaimer (i.e., a renunciation) by the surviving spouse or other
beneficiary of all or a portion of a bequest, with the effect that the
disclaimed property passes without gift tax to others or is added to a credit
shelter trust. Disclaimers must be made within 9 months of the death of the
first decedent if they are to avoid gift tax. An appropriate disclaimer may also
be a very effective tool to assist in a poorly drafted estate plan.
6. THE IMPACT OF GIFT AND ESTATE TAXES: The
table annexed to this
memorandum sets forth Federal and North Carolina estate and inheritance taxes.
Note that the table is applicable to a "taxable estate" - that is to say, to
the gross taxable estate after all deductions, including the marital and
charitable deductions. For married persons whose estate plan uses the full
marital deduction in the first estate, the table should be read as applying to
the survivor's estate. Note that North Carolina adopts the technique of
"sponging up" the federal death tax credit. Subject to the phase out of that
credit and collects the entire federal tax credit amount without regard to the
federal phase out - See
FAQ for
additional information.
7. JOINTLY HELD PROPERTY: Only one-half of the value of property held by
husband and wife in joint ownership with the right of survivorship is includible
in the estate of the first spouse to die unless that property was purchased
solely by the decedent's spouse income or resources prior to 1977. Because the
property passes to the survivor and will qualify for the unlimited marital
deduction, the inclusion will have no significant estate tax effect. However, in
many cases, the survivor will have a different basis for the capital gain
purposes should he or she sell the property: one-half will be the value of a
half interest in the property as of the date of the death of the first decedent;
the other half will be one-half of the historical pre-death adjusted cost basis
(purchase price as adjusted) of the property in the hands of the husband and
wife. Joint property held by a non-spouse results in a presumption that the
property is fully includable in the estate of the first of the joint tenants to
die unless it is proven that the survivor contributed to the purchase of the
property.
8. EMPLOYEE BENEFITS: Although an estate tax deduction is no longer
available for lump sum distributions under qualified pension and profit-sharing
plans, there are some planning possibilities that remain for approved plans. For
example, the designation of a spouse as a beneficiary of a plan would qualify
the employee benefit for the marital deduction. There also are a variety of
critical income tax options available to a plan participant or a beneficiary of
a plan which should be discussed with your tax adviser, especially if you are
planning your retirement. Go to
FAQ for
further information regarding designation of beneficiaries of your IRA and
other qualified accounts.
9. THE IRREVOCABLE INSURANCE TRUST: An important way of avoiding estate
taxes continues to be the ownership of life insurance by a trust. If a new
policy is purchased by a properly drawn trust, the entire proceeds of the policy
can pass through the estate of both spouses, without tax. If an existing policy
owned by the insured if transferred to a trust, the insured must survive such
transfer by three years in order for the proceeds to be free of estate taxes. In
each case, the trust must be irrevocable - a fact which requires that the most
serious consideration be given before such a trust is created. The trust
agreement must be carefully drafted to assure family security and tax avoidance.
Go to FAQ
for further information on life insurance trusts.
10. ANNUAL GIFT TAX EXCLUSION: The amount of gifts that an individual can
make without incurring gift tax liability is now $12,000 per donee per year.
This amount will increase for cost of living increases. This means that $24,000 may be given by
a married couple each year to each child, grandchild, or others without
incurring gift taxes (regardless of whose property is given). Moreover, an
unlimited gift tax exclusion is provided for amounts paid on behalf of the donee
for medical expenses and school tuition, provided that the payment is made
directly to the school, doctor, hospital, etc. who or which provides the
service. A payment made directly to a child or grandchild for tuition will not
qualify for the exclusion. The IRC, as amended, eliminated most of the income
tax advantages of trusts for children. Nevertheless, various trust options are
still available to achieve income, gift and estate tax savings in relation to
gifts for children or grandchildren. These include "grandparent trusts" which
permit funding of educational or similar trusts up to the $12,000-$24,000 annual
gift exclusion; and various forms of charitable trusts.
11. GENERATION SKIPPING TRANSFER TAX - (GST TAX): The GST tax in general
imposes a tax at a rate of 45% on all transfers outright or in trust for
grandchildren or more remote descendants to the extent that the aggregate of
such transfers exceeds a $2.0 million total exemption per transferor. This amount
will also be increased based on the increase in the exemption amount outlined in
#3 above. Thus, for example, once the exemption has been
consumed, a trust for a child for life, with remainder to grandchildren, is
subject to the tax when the child dies notwithstanding a gift or estate tax was
paid upon the initial transfer. The provisions of the GST are enormously
complex. Good estate planning can avoid or minimize the imposition of the tax.
12. NORTH CAROLINA:
While the Federal gift tax exemption increased to $1,000,000 effective for
gifts to non-spouse/non-charity beneficiaries occurring on or after
January 1, 2002, the North Carolina gift tax exemption remains at
$100,000, and this $100,000 exemption applies only to gifts to direct
descendants (known as Class A beneficiaries). In particular, North
Carolina taxes lifetime transfers to nieces and nephews and unrelated
beneficiaries (including in-laws) at a much higher rate than children or
other descendants, and non-descendants are not entitled to any gift tax
exemption beyond the $12,000 annual exclusion. The result is the first
dollar over $12,000 of property transferred by gift to non-descendants is
subject to North Carolina gift tax. Like Federal gift tax law, North
Carolina does recognize unlimited charitable and marital deductions.
With regard to the estate tax, North Carolina eliminated its separate
inheritance tax in 1999 and has since been dependent on a portion of the
Federal estate tax known as the state death tax credit. The state death
tax credit is the amount states such as North Carolina receive from the
Federal estate tax. It is a relatively simple calculation. Under the 2001
Federal Act, the state death tax credit will be reduced by 25% for estates
of decedents dying in 2002, 50% for estates of decedents dying in 2003,
75% for estates of decedents dying in 2004, and 100% for estates of
decedents dying in 2005 and beyond.
North Carolina has decided not recognize this phase out of the state death
tax credit. This further complicates the estate tax predicament for North
Carolina residents since the amount of estate tax paid to the North
Carolina Department of Revenue as part of the state death tax credit is
determined by reference to Federal law as it existed prior to the 2001
Act. Further, given our state’s growing deficit, it is possible that North
Carolina could re-introduce its own inheritance tax, which would be
completely independent of Federal law.
13. QUALIFIED PERSONAL RESIDENCE TRUST: The IRC
authorizes gift/estate tax savings through a trust known as a Qualified Personal
Residence Trust ("QPRT") to which the owner/grantor (the creator of the trust)
transfers a personal residence for a term of years during which he or she must
occupy the residence. At the end of the term full title passes to the children
(or others). The grantor's right to occupy is valued in actuarial tables, and
the difference between this value and the property's fair market value at the
time of the transfer is a taxable gift to the children. If the grantor survives
the term, the property is not subject to estate tax in the grantor's estate upon
his or her death, and the value of the property (including appreciation) passes
to the children. If grantor die during the term, the tax saving is lost.
A disadvantage of the QPRT is that the property which ultimately passes to the
children will have a carry-over basis; that is, the children's tax basis in the
property will be the same as that of the grantor, which due to appreciation may
have a significant built-in gain. (Contrast this with the "step-up" in basis
which a beneficiary of an estate receives - the beneficiary has a basis of the
fair market value of the property as of the date of death).
14. BUSINESS INTERESTS: An individual who is the owner of a closely-hold
business should be aware that his or her estate will face special problems
upon his or her death beyond the normal question of who will run the business
when he or she is gone. These include: administration of the business during
the period of estate administration, liquidity problems to pay for estate
taxes if the business interest is passing to someone other than a surviving
spouse; orderly liquidation of the business, etc. Many of these difficulties
can be alleviated, if not solved, by careful planning during the business
owner's life. See
our
article for additional issues facing family businesses.
15. REVOCABLE TRUSTS ("Living Trusts"): The revocable trust is finding
increased acceptance as an estate planning tool. This type of trust is a trust
(which is an agreement) typically between the creator (or grantor) of the trust
and grantor and another as trustee. During the life of the grantor, the trust is
freely revocable or amendable, and because of this, any transfers to the trust
by the grantor are not treated as completed gifts (which would generate a gift
tax). As long as the grantor is alive, all trust income (dividends, interest,
realized capital gains) are taxed to the grantor individually - no trust income
tax returns need to be filed. Upon the death of the grantor, the trust becomes
irrevocable and the property passes to those individuals, organizations or
trusts as dictated by the grantor. For that reason, the revocable trust is a
vehicle to avoid probate. However, because the grantor retains the right to
revoke the trust, the assets in the trust do not avoid estate taxes on the death
of the grantor. Yet, through proper planning, the estate tax avoidance
techniques available to a client can be accomplished through either a Will or a
Revocable Trust Agreement. We believe, however, that a Revocable Trust can be
even a more important vehicle for dealing with a grantor's actual or possible
physical and/or mental disability. This, for clients whose assets may require
managed care and/or who are concerned about their own ability to continue
management of their own affairs, a Revocable Trust, like a power of attorney,
provides such clients with the opportunity to choose a family member, bank or
other adviser to serve as co-trustee with the client; and if the client, at some
future time, is unable to manage his or her financial affairs, then the
co-trustee can continue the management of the client's assets, through the
trust, without the need for supervision by any court.
Go to FAQ
for further information on revocable living trusts.
Caveat: It is still imperative that the individual have a Will to cover the
disposition of property which is invariably not titled in the name of the trust.
16. SECOND-TO-DIE INSURANCE: This is a life insurance policy on two
lives, usually those of a husband and wife. The policy does not mature or pay
out until the death of the second spouse. Because it is on two lives, the
premiums are usually spread out over a longer period of time. This type of
insurance is well suited to an insurance trust (mentioned in paragraph 9 above)
with both spouses as grantors.
WILL CONTESTS:
17. SPOUSAL RIGHT OF ELECTION: Notwithstanding anything to the contrary
stated above, the most carefully drafted Estate Plan can still be upset by a
spousal right of election. In North Carolina (as in most states), an individual
does not have the unqualified right to disinherit his or her spouse. To protect
against this, North Carolina law provides that, regardless of the provisions of
an individual's Will, an individual's surviving spouse has the right to "elect"
to take up to one-third (1/3) of the estate outright. The actual amount of the
election varies depending upon the terms of the Will, the character of the
decedent's property and beneficiary designations, prior gifts, prenuptial
agreements, the number of children,
whether or not the spouse is the parent of those children, and the existence of
a pre-nuptial agreement, but the fact remains that this right of election must
be considered. Go to
new
page for more information on the NC Spousal Elective Share Statute or
email
Travis.
18. LIFETIME GIVING STRATEGIES: Lifetime giving presents a wonderful
opportunity to take advantage of certain benefits under the estate and gift tax
laws as well as allowing a donor to satisfy his or her desire to see the fruits
of a gift during the donor's life. For instance, the gift tax annual exclusion
(described at paragraph 10 above) is not available at death. Importantly, any
lifetime gift will result in removing future appreciation on that asset from
your estate. In that regard, lifetime giving will allow you to "leverage" your
unified credit. Disadvantages of lifetime gifts are that the recipient (or "donee")
takes a carry-over basis in the asset, and that any gift tax paid within three
years of death must be added back to the donor's gross estate in the computation
of estate taxes. Care must be given to power of attorney and revocable trust
documents to insure that incompetence does not eliminate any lifetime giving
strategies.
19. APPOINTMENT OF FIDUCIARIES: The individuals or organizations (banks
or trust companies) you choose to act as executor, trustee and/or guardian must
be given careful consideration. The following general comments may be helpful:
Executor:
This is the person or trust company authorized to perform trust functions in
North Carolina you choose to collect your assets, administer your estate, pay
your debts, and carry out the instructions of your Will.
Trustee:
The person or trust company who will hold money, invest it and distribute
according to the terms of the trust.
Guardian:
The individual you choose to look after the person or property of any minor
child you may have.
Attorney-In-Fact:
An individual or trust company authorized to perform trust functions in North
Carolina who acts as your agent to manage your property and affairs during your
lifetime in your absence; and in the case of a Durable Power of Attorney, in the
event of incompetency.
Go to FAQ
for additional information regarding fiduciaries
The above information is of general application and is subject to change by new
laws, regulations and rulings. It is not, by any means, intended to constitute
legal or tax advice or to cover all of the strategies available to minimize
estate, gift or income taxes. Each particular estate plan must be analyzed to
determine how best to achieve individual and family security within the
framework of the tax laws. |
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