By Michele Gartland and Marianne Cirillo
Let’s start with some background information. When a person dies, his or her estate is subject to federal estate tax, and, in Connecticut, there is also a state estate tax (CT is one of 12 states that applies an estate tax). Current federal law exempts the first $11,400,000 per person from estate taxes (a married couple’s exemption amount is $22,800,000), but anything beyond that value is taxed at a 40% rate.1 The current Connecticut exemption amount is $3,600,00 per person, which cannot be doubled for a married couple.2 It should be noted that these are lifetime exemption amounts, meaning that if you give away sizeable portions of your estate during your lifetime, the value of those gifts will be deducted from the exemption limit, thus reducing the tax-free amount of your final estate.
One aspect of estate planning is to minimize estate taxes to the extent the law allows. An efficient way of minimizing those taxes is to reduce the size of your estate over your lifetime so the final estate is subject to little or no tax. This can be done through the process known as “gifting.” Gifting is often an easy, straightforward way to manage the size of one’s estate, but it is important to realize that, if the size of the gift exceeds the exemption amount, the donor pays the tax, not the recipient. However, you can still make annual gifts without it counting toward the exemption amount as described below.
You may give gifts worth up to $15,000 (this year’s annual exclusion amount) to any one person without having it count toward your lifetime estate exemption amount and without having to file a gift tax return. This annual exclusion amount typically increases a little each year to adjust for inflation. You can give an unlimited number of those exclusion amount gifts as long as they are not to the same person, and this can be repeated year after year. If you give someone a gift worth more than $15,000 in a given year, you won’t have to pay federal taxes on it until you hit the lifetime exemption amount, but you will have to file a gift tax return with the IRS so the agency can keep track. In Connecticut the current $3.6MM exemption is a combination of lifetime gifts plus the size of your estate, so gifting can add up over time and should be carefully planned. As the size of Connecticut’s exemption amount grows to be more closely aligned with the federal amount over the next few years, if you are considering making a large gift it may be worth doing so before the federal exemption amount is set to return to its previous levels at the end of 2025.
Some exceptions to the exclusion amount limits: donations to charity are always tax deductible if you itemize, and they do not count as gifts. In addition, a gift can exceed $15,000 and still be considered a permitted exclusion if the gift is made directly to an educational institution or a medical institution to be used directly for the beneficiary’s education (tuition) or medical expenses.
What happens when a person who dies shares an account with someone else? Many people own houses or bank accounts jointly with a spouse, for example.
If a house is solely owned by an individual, it is his or her property at time of death and is considered a probate asset. But if it is titled as jointly owned with right of survivorship with either a spouse or a child, 50% of that asset transfers automatically to the surviving account holder and it is not reported as a probate asset. This is also true for a bank account or other property that is owned jointly with right of survivorship.
Similarly, 401(k)s, IRAs and life insurance policies have designated beneficiaries. If these parties are named, the funds are transferred to the named parties relatively quickly and do not pass through probate. Beneficiaries of retirement plans also get the added benefit of converting the IRA into an inherited IRA, and that asset can continue to grow tax free. If no designated beneficiary is named, then the asset will be considered an asset of the estate and will not be distributed until the estate is settled.
Both account titling and beneficiary designations are important aspects of estate planning that should be carefully considered and reviewed regularly to make sure they reflect your current wishes.
Estate planning helps people plan for and navigate critical decisions at different times in their lives. Families in particular can benefit from proper estate planning as it gives them the ability to look out for and protect parents, children, siblings and others. Having a plan establishes a clear indication of your wishes and creates peace of mind for you and your loved ones.
1 This number will go up by an inflation-adjusted amount until the end of 2025, when the law is set to expire and decrease to $5,490,000 per person and $11, 980,000 per couple.
2 Assuming no future changes in the law, this number is set to increase to $5.1MM in 2020, $7.1MM in 2021, $9.1MM in 2022, and to the federal exclusion amount thereafter.