What a difference a year makes. As we move deeper into 2014, we finally have some certainty in the Federal Estate Tax law. The largest exemptions in history are in place and are here to stay.
There is a current trend among states to get rid of their own state death tax. For instance, Tennessee is doing just that. Tennesseans are in a period of transition. On May 1, 2012, Tennessee retroactively repealed the Tennessee Gift Tax effective January 1, 2012 and Tennessee is phasing out the Tennessee Inheritance Tax through 2016. However, the Tennessee exemption will be a moving target between now and 2016.
Likewise, Indiana repealed its inheritance tax for those dying after December 31, 2012.
Kentucky does currently have an inheritance tax, but it does not have such broad effect. This is true because there is an exemption (no tax) for amounts passing to the surviving spouse, parents, children, grandchildren, siblings and half-siblings. As you get farther away in relation, a small exemption applies (between $500 and $1,000) and the rate of tax is between 4-16%
Neither Mississippi nor Arkansas has any inheritance tax.
Gift Tax Exemptions and the Annual Exclusion
Federal Law. For purposes of the Federal Gift Tax, the amount which can be gifted without incurring gift tax liability is $5.34 million per person. This amount is also reduced by prior taxable gifts. Gifts made during life (other than Annual Exclusion gifts) reduce the amount which may be passed at death without incurring federal death taxes. Individuals may gift up to $14,000 per person per year without incurring gift tax (and need not be reported). This is known as the Annual Exclusion. This means that a parent can make a $14,000 gift to each child and grandchild annually. Over time, this can result in substantial tax savings. If the person making the gift is married, it is possible to “split” gifts to double these exemptions. Although the annual exclusion amount is also indexed for inflation, it did not increase in 2014.
State Law. Of course, this varies from state to state, but there is no longer any state gift tax in Tennessee for gifts made after January 1, 2012. Likewise, there are no state gift taxes in Arkansas, Kentucky, Indiana or Mississippi.
Death Tax Exemptions
Federal Law. In 2014, the basic Federal Estate Tax Exemption was $5.34 million. The Federal Estate Tax Exemption is the amount that can pass tax free to children, descendants or other beneficiaries. This amount is indexed for inflation.
Note that as a general rule, no taxes are imposed on gifts between spouses either during lifetime or at death. Certain trusts for the benefit of a spouse for life are also exempt from taxation. Also, because of the Supreme Court decision in Windsor, same sex couples may be able to qualify for these tax benefits. The $5.34 million exemption generally applies to gifts or bequests to children and descendants and other non-charitable beneficiaries.
State Law. Again, many states have done away with their state estate and inheritance taxes. Tennessee is no exception. The Tennessee inheritance tax is collected by the State of Tennessee Department of Revenue. This tax is only applicable to residents of Tennessee or those who own real property located in Tennessee. The tax applies to assets in a manner similar to the federal estate tax. Again, bequests to citizen spouses and charities generally do not cause inheritance tax. The amount which can pass tax free to children or beneficiaries (other than a spouse or charity) is $2 million for 2014.
The Tennessee inheritance tax exemption will change as follows:
2015 – $5,000,000
2016 – Unlimited
That’s right, the Tennessee inheritance tax is scheduled to be repealed for anyone who dies on or after January 1, 2016.
The disparity between the current federal exemption and the current State of Tennessee exemption produces unique tax problems for Tennessee residents, including the potential for tax at the death of the first spouse to die.
Because of the disparity between the federal law and Tennessee law, estate plans executed just a few years ago which focus on the federal estate tax law may produce unnecessary first death tax for Tennesseans which can be avoided through proper planning.
As discussed above, Kentucky does currently have an inheritance tax, but it does not have such broad effect. This is true because there is an exemption (no tax) for amounts passing to the surviving spouse, parents, children, grandchildren, siblings and half-siblings. As you get farther away in relation, a small exemption applies (between $500 and $1,000) and the rate of tax is between 4-16%.
Neither Arkansas, Indiana nor Mississippi currently has any state death tax.
Federal Law. For 2014, the federal estate tax rate is essentially a flat 40%. This is low relative to past rates, as rates have been as high as 60% under previous law.
State Law. In Tennessee, for every dollar your estate exceeds the Tennessee inheritance tax exemption, you can assume Tennessee inheritance taxes of approximately nine cents. As an example, if you are a Tennessee resident and die with a $2,500,000 estate in 2014, roughly $45,000 of inheritance tax will be due ($2,500,000 estate-$2,000,000 Tennessee exemption = 500,000 x.09 =$45,000).
In Kentucky, rates for transfers to friends and family (other than members of the deceased’s immediate family discussed above) range from 4-16%.
Portability of Federal Estate Tax Exemption
The Federal Estate Tax Exemption is now portable between husband and wife. To the extent that one spouse does not use all of his/her exemption, the surviving spouse can do so under certain circumstances. Note that certain filings at the time of the death of the first spouse are required or the portability benefit will be lost.
The 2012 Act re-unified the estate tax and the gift tax by allowing gifts to individuals other than a spouse of up to $5.34 million without imposing any federal gift tax. It should be pointed out that, to the extent that the gift tax exemption is used, it reduces the available estate tax exemption at death. Gift tax rates are the same as death tax rates, or 40%.
Tennessee does not allow portability of exemptions for purposes of the Tennessee Inheritance Tax.
Need to Review. The substantial changes in the law over the past few years may cause estate plans which are just a few years old to be obsolete. In some cases, because of the changes in the exemption levels, an older plan may be more complicated than the client now requires. This is particularly true for Tennessee residents due to the discrepancy between the Tennessee Inheritance Tax exemption and the Federal Estate Tax exemption that will exist between now and 2016.
In light of this, all estate plans for estates large and small should be reviewed and updated as necessary.