By Matthew V. Piwowar – Unfortunately no, the New Estate Tax Exemption does not solve all of your estate’s tax problems. Not only does the new tax law not solve all of your estate’s various tax problems, it may not solve the one tax problem it was intended to fix, the actual “estate tax” (aka the “death tax”). Whenever a new tax law is passed, everyone believes (hopes) that it eliminates the need for tax planning. Sadly, it is rarely the case that a single change in tax law eliminates the need to plan. And it is especially the case with the new estate tax exemption.
Many Taxes Affect Your Estate
Not surprisingly, the new estate tax law only addresses one tax, the estate tax. However, your estate and your family will be affected by many taxes in addition to the estate tax. Some of the taxes that you should plan for include: income taxes, capital gains taxes, gift taxes, property taxes, and in some states, inheritance taxes. If you fail to plan for these taxes, your family may have an unhappy tax surprise upon your death.
Yes, in Michigan (but not all states), your inheritance is income tax free and there is no Federal income tax on inheritance. But that only means there is no income tax at the moment you inherit an asset. What about when later you sell that asset? Surprise, the IRS is back! Any gain on the sale of that asset is taxable as income. Your taxable gain is calculated in different ways depending how you design your estate plan and how your estate is settled.
Without a proper estate plan before your die, your family may pay more income taxes than necessary. Without proper legal assistance settling your affairs after you die, it is almost certain your family will pay more taxes than necessary. Often the tax liability may not occur until years after your death. As a result, your family may not realize the tax could have been reduced with planning years earlier.
Many heirs are surprised about changes in their property tax rates or taxable property values when they inherit real estate. This is especially the case with agricultural property, family cottages, and business assets. Nothing in the new estate tax exemption solves these local property tax issues. However, proper estate planning can significantly reduce or eliminate local property tax surprises.
Your Final Tax Return (and tax bill)
After you die, someone has to file your tax return for the year of your death and pay the taxes. Depending when you die, your final tax return may be for only one month, or for eleven months. If you die before incurring certain annual deductible expenses, your estate could have a significant tax bill. Without a living trust, your family’s inheritance could be used to pay not only your income taxes for the last year of your life, but also taxes and penalties from prior years.
Even if you don’t have a large tax bill, will your family know where all your tax records are located? Will they know which CPA you use, or if you do it yourself, where the computer file is located? Dealing with your taxes after you die can cause your family significant grief and aggravation. A comprehensive estate plan will include planning for your final tax return.
Don’t Plan on Dying Before 2026? The New Estate Tax Exemption Does.
The new tax law has increased the old $5 Million Dollar base exemption for the estate tax up to $11 Million Dollars for singles or $22 Million Dollars for couples. It is even indexed to go up each year. Any amount in your estate in excess of the exemption amount is subject to a hefty 40% tax. For most of us, an $11 Million Dollar exemption sounds great. No estate tax problems now, right?
If you don’t plan on dying in the next eight years, then this big new estate tax exemption doesn’t help much. In typical Washington fashion, the Congress was incapable of giving us a permanent tax law. The new estate tax exemption has a “sunset clause” which results in the exemption automatically expiring on December 31, 2025. Die on January 1, 2026 or later, and you are stuck with the estate tax law from 2017. Even worse, if enough liberal politicians take control in Washington, you could end up with only a $750,000 exemption, or less. In the past 102 years, since the 1916 tax law started all this, the estate tax exemption amount has changed at least 38 times! It would be foolish to make critical decisions for your family based on the assumption it will not change again.
Cost of Not Planning – Do the Math
Let’s do the math together: if everything you currently own is worth $3 Million Dollars today, and your gross estate grows by a conservative 9% each year (for 9 years), then you will have an estate over $6 Million Dollars in 2026. Your estate will exceed the 2017 estate tax exemption amount just in time for the exemption amount to revert back to the 2017 level.
If your current gross estate is over $2 Million Dollars you should be working with an estate planning attorney now. You want to take advantage of the higher lifetime gift allowance before 2026. With preemptive tax and estate planning you may be able to reduce the risks involved with the 2026 sunset clause. Assuming you’re 65 and you die at 85, your $2 Million Dollar estate could be an $11 Million Dollar estate. What if you don’t plan? Assuming a $7 Million Dollar exemption and 40% estate tax, your family’s tax bill will only be a mere $1,600,000. Or the tax bill could be zero, if you plan in advance.
Planning and Maintaining Your Estate Plan
You may be asking yourself, “just because I qualify for an exemption this year, can I be sure I will qualify for an exemption (or that there will even be one) the year I die?” Good question, because only the tax law in effect the year you die matters. A proper trust-based estate plan, with a Formal Maintenance Program is the only way to ensure your estate will take advantage of tax laws in effect when you die.
Without an updated estate plan, your family is at the mercy of the estate tax law in effect at the time of your death or disability. If the estate tax law changes, will you know or have time to get an estate plan before you die? The current Estate Tax is 40% of everything in your estate above the exemption. Sadly, for many people, the exemption may change after they become incompetent (dementia or Alzheimer’s) and their families will be stuck paying the 40% tax.
The best way to ensure your loved ones don’t have an unpleasant tax surprise after your death is to have a living trust with a comprehensive estate plan and an annual maintenance plan. If you don’t work with an estate planning attorney today, your family will need a tax attorney when you’re gone.
Matthew V. Piwowar is an estate planning attorney based in metro Grand Rapids, Michigan. Mr. Piwowar is a member of the State Bar of Michigan, the National Network of Estate Planning Attorneys and the Michigan Forum of Estate Planners.