The Elusive Estate Tax

Lisa,

Could you please explain the “estate tax” and how it works?  Also, is there any way to reduce the estate tax?  - Thanks, Varsha  

Dear Varsha:    

The estate tax (sometimes called the “death tax”) is a tax that is imposed when a person transfers property to his or her beneficiaries upon that person’s death.  It seems unfair since people pay income tax on what they earn during their lives, and then may have to also pay the estate tax upon their deaths.   However, there are exemptions from the estate tax that have greatly varied in amount since the inception of the estate tax in 1916. Also, for people dying in 2010 there was no federal estate tax – but companion legislation took away some of the benefits of the 2010 estate tax elimination.     

In 2011, the federal estate tax exemption is $5 million and the Illinois estate tax exemption is $2 million.  This means a person dying in 2011 with an estate valued at $5 million would owe no federal estate tax, but may owe Illinois estate tax since Illinois only provides for the $2 million exemption. (Transfers to charity are not generally subject to the estate tax.)  The exemptions remain the same in 2012. However in 2013 the federal estate tax exemption is drastically reduced to $1 million!

The top federal estate rate is currently 35%. The maximum Illinois estate tax rate is presently 16%. But in 2013, the top federal estate tax rate increases to 55%. The estate tax is paid out of the property owned by the person who died. The tax is not paid by the recipients unless the descendant resided in a state that imposed an “inheritance tax.” Illinois does not have an inheritance tax.

 To answer your second question, there are estate planning strategies that attempt to reduce the estate tax.  These strategies are aimed at reducing the size of your taxable estate. One very common method is to make annual gifts to, for example, children and grandchildren. In 2011, a person can gift $13,000 each to an unlimited number of people without incurring a gift tax. This is often called “Annual Exclusion gifting.”    

 There are also a variety of irrevocable trusts that can be used to help mitigate the estate tax. One such trust is the “Irrevocable Life Insurance Trust.”  Basically, a person sets up an irrevocable trust that owns a life insurance policy on his or her life. That person then gifts just enough money to the trust to pay the insurance premiums. This allows the individual to reduce the size of his or her taxable estate, while creating a greater asset (the life insurance proceeds) that should not be subject to estate tax.  

The estate tax is complicated, and the strategies for reducing it even more so. This column is only intended to provide an overview and discuss the concepts in a general nature.

 If you would like to discuss this tax in greater detail, please feel free to contact me. I provide a one-hour consultation at no charge to you.

If any reader would like to ask me a legal question, post it on the Lake Zurich Patch website or send your question to me at lehmanlawoffices@aol.com.

Thanks for your question, Varsha.

Best Regards,

Lisa

Disclaimer:  Please be aware that this column provides only legal advice of a general nature and it is not intended as legal advice for any person or group of persons. You must always consult with an attorney with respect to your particular legal situation.