November 23, 2011

Death Taxes

When a person passes away, there are numerous taxes associated with the transfer of the decedent's assets. The following are examples of these transfer taxes.

Estate Tax

The Estate Tax is a tax levied on a decedent's estate when the estate's amount exceeds the applicable exclusion amount. For example, the current exclusion amount in 2011 is $5M. Thus, if a single person were to pass away next week and their estate was worth $10M, their estate would be, generally speaking, subject to the Estate Tax. The Estate Tax's top rate for 2011 is 35%.

The future of the Estate Tax is under considerable debate at the moment. The applicable exclusion amount is set to revert back to 2003 levels, $1M, if no action is taken for the year 2013, the $5M exclusion expires after 2012. It is likely that the Estate Tax will be revisited sometime in late 2012 because Congress has a habit of waiting until the last moment to resolve anything.

Gift Tax

The Gift Tax is a tax levied on the transfer of property between parties absent consideration. For example, if Donald gave the keys to his Ferrari to his friend Doug out of the blue and said "the car is yours to keep" and Doug then hastily sped off in the Ferrari, such would constitute a gift. The reason being is that there was an (1) intent to make a gift, Donald was not asking for anything in return, (2) delivery of the gift, Donald gave his keys to Doug and (3) receipt of the gift, Doug drove off with the car.

The Gift and Estate Tax are linked together to prevent a person from giving away their estate before they die in order to avoid the Estate Tax. Thereby, giving away large gifts over one's lifetime can reduce the amount of the Estate Tax available to that person on their death. So before you decide to give away all of your possessions on your death bed to avoid the taxman, remember the preceding sentences.

The current amount a person can give away before they incur Gift Tax is $5M. Again, this figure is under considerable debate as well because the figure has been tinkered with many times over the past couple of years.

Generation Skipping Transfer Tax

The GST Tax is designed to address the situation where a person transfers property to a "skip person" that avoids the application of the Gift and Estate Tax. This "skip person" is almost always a grandchild. Hence, the law typically arises when a grandparent transfers property to a grandchild. For example, a grandparent might create a trust that distributes income derived from the trust to the child and the grandchild, and upon the child's death, the principal will be distributed to the grandchild.

The GST Tax uses the same applicable exclusion amount as the Estate Tax, $5M in 2011. 

The GST Tax is largely irrelevant for the vast majorities of individuals because not many people have millions of dollars earmarked for a grandchild's inheritance through a trust.

Property Taxes (Prop 13)

If the decedent's estate owned real property, then property taxes will need to be addressed. Prop 13, the California constitutional amendment that governs property taxes, says that each piece of real property can be assessed a 1% levy and each year the property's assessed value can be at most raised 2% from the previous year. However, before you tell me that I am uninformed because your property tax bill is clearly greater than 1% of the assessed value, please remember that cities and counties are allowed to tack on various fees for infrastructure projects and pension obligations.