Most people who aren't in the top 1 percent of earnings don’t believe they have to worry about estate planning, but that isn’t true, according to John McManus, founding principal of McManus & Associates in New York.
Even though individuals who earn between $250,000 and $1 million won’t have to worry about paying federal estate taxes, since the exemption is $5.25 million, they still have to worry about state exemptions, which are all over the map.
In New Jersey, the state exemption for estate taxes is $675,000. In New York, that amount is $1 million. So before individuals breathe a sigh of relief about the federal exemption, first check into your state’s policies regarding estate taxes.
One thing to consider when doing your estate planning is spousal portability. Many people don’t realize that if a spouse dies, the survivor can utilize any remaining portion of their deceased spouse’s Federal Estate Tax exemption amount. According to McManus, to elect portability, the executor handling the estate of the spouse who died must file an estate tax return even if no tax is due within nine months after the death.
“It is not the best way to do your planning, yet it still provides you with a do over if you had not done planning before your spouse passed away,” he said.
Currently, there is no federal limit to how much individuals can give to their loved ones during their lifetimes. Individuals can give loved ones $14,000 a year tax free. Connecticut has started a new trend by putting a $2 million limit on how much people can give away in their lifetime before they will be taxed on it.
If a person does give more away than the annual exemption limit of $14,000, they need to file a gift tax return, McManus said. Gift tax returns must be submitted at the same time as your federal and state tax filings.
He cautioned anyone submitting a gift tax return to have a professional submit the paperwork for them, otherwise they are more likely to get audited by the Internal Revenue Service.
“Now that the IRS is not auditing estates under $5.25 million, they have opportunities to look at gift tax returns because they have more time on their hands,” he said. “They will look to challenge gifts and gift tax returns that are not done in the consistency and continuity of how the tax law reads.”
As an example, McManus mentioned that if an individual transferred his house to his children, but only attached a copy of the town’s assessed value of the property instead of an official appraisal, “they could look at it as irresponsible or lazy,” he said.
“People are not going to give a large amount of their assets away during their lifetime. If a client has $1.5 million during their lifetime, they may need every dollar of that to live from. If they become terminal, a quality financial advisor and attorney will say, ‘let’s move money off the balance sheet now.’ The fact is, by moving it you’ll avoid the imposition of state tax when you pass away. The problem in the past is people are not doing it because they only give away $750,000 to $1 million on the federal level,” McManus said. “The concern is that states will smarten up and impose a gift limitation equal to the death tax limitation.”
McManus mentioned that even middle-income earners should consider putting money away in a trust for their spouse or children. If the inheritance is set aside in a trust, even if your spouse remarries, the new spouse can’t have a piece of your estate. The money would go to your children.
Could the debt ceiling talks coming up in March have an impact on estate planning? McManus believes that if the debt ceiling talks result in states receiving fewer funds from the federal government, states might try to raise that money through a higher potential state estate tax.