Explainer: the Estate and Gift Tax

The Estate and Gift Tax is a tax scheme that imposes a tax on the transfer of an asset. The Estate Tax (otherwise known as the Death Tax; they’re the same thing) requires the transfer to be made after the giver’s death. So, think of an inheritance when you think of the Estate Tax. And the Gift Tax requires the transfer to be completed during the giver’s life. So, think of a birthday or anniversary gift. But in both scenarios, something is being transferred. Also keep in mind that the transfer is being made gratuitously, meaning there is no sale taking place. It must be a gift.

The Estate and Gift Tax is a tax on the grantor of the transfer. That’s the person or estate of a person that is making the gift (the giver). The tax is imposed by the Internal Revenue Service (IRS), our federal taxing authority. Note that we do not have a federal inheritance tax–a tax on the recipient of a transfer. There are a few states that do have an inheritance tax, but California is not one of them. An inheritance tax may apply if the recipient of a gift resides in a state or country that imposes an inheritance tax.

The Estate and Gift Tax is really easy to calculate. It’s a flat tax, meaning that it applies equally to every grantor of a transfer. The federal government imposes a flat 40% tax of the fair market value of the asset being transferred. That is not a typo. As an example, if I gave my friend $1,000 for her birthday, I would have to pay $400 to the IRS for making this gift. It’s an identical result if I left my friend a $1,000 inheritance from my estate. My estate would be on the hook for a $400 tax.

Hold up. Why have we not heard of anyone paying this tax?? And why is no one upset with this??

Enter: the estate and gift tax exemption.

The Estate and Gift tax are linked by an exemption amount. An exemption is a magic number that Congress selects, and it applies to every US citizen and green card holder. Congress has decided that so long as you do not make gifts in excess of your exemption amount, then no tax is owed. The exemption amount is set periodically by Congress, and it gets adjusted for inflation annually. When someone dies, all of the gifts they made during their life are added to the value of stuff they own upon their death, and that total is measured against the exemption amount.

Ok, simple enough. How do we know our applicable exemption amount?

The current exemption amount is set at $10,000,000 per person. That’s not a typo, either.  It’s indexed for inflation annually. So for 2023, the exemption amount is $12,920,000. Additionally, if you’re married, you essentially get to combine your exemption amount with your spouse’s exemption amount. In short, if you are an unmarried person, you can transfer up to $12,920,000 in assets and pay no estate taxes. If you’re married, you can jointly transfer up to $25,840,000 in assets and pay no estate taxes. Only the amount that exceeds the exemption is subject to the 40% tax. For example, if an unmarried person dies owning $14,000,000 in assets, only $1,080,000 ($14,000,000 - $12,920,000) is subject to the 40% flat tax, or $432,000 in taxes owed on a $14,000,000 estate.

How does the IRS know whether lifetime gifts were made, and how much they amounted to?

Just like we are required to report our income every year on a Form 1040, we are also required to report any gifts made in a given year on a Form 709. When you report the gift, the IRS walks over to your file and deducts the amount of that gift from your $12,920,000 exemption amount. No taxes are owed until you run out of exemption! But here’s the thing: you only have to report gifts that are in excess of what is called the annual exclusion. 

The annual exclusion is another number set by Congress that allows each person to make a certain value of gifts every year, to every recipient, and not tell a soul, including the IRS. The current annual exclusion is set to $17,000. So, for example, I can give each one of my friends up to $17,000, per year, and not have to report that on a Form 709. I can combine my exclusion with my spouse’s exclusion, and make up to $34,000 in gifts per recipient, per year, and not report it on a Form 709. This is why you never hear of anyone filing gift tax returns after birthday parties. If only we were all so generous!

So what happens if, for example, parents assist a child with a downpayment of a home, in excess of $34,000 in a given year?

If a gift is made in excess of the annual exclusion, then you deduct the amount excluded and then file a gift tax return for the amount in excess. Let’s say parents give a $200,000 gift to a child to purchase a home. They would deduct the $34,000 ($17,000 x 2 parents = $34,000) they can jointly give to the child in a year and not report it, then report the remaining $166,000 ($200,000 - $34,000). Each parent would file a Form 709 declaring a gift of $83,000 each. The IRS walks over to each parent’s file, and deducts $83,000 from each of their $12,920,000 exemption. If they haven’t gone over the exemption amount, no taxes owed on that transfer.

Whew! That’s a lot of information to digest.

To sum it up, we all get an Estate and Gift Tax Exemption. It’s set by Congress, and annually it gets adjusted for inflation. This year’s amount is set at $12,920,000. Spouses can effectively combine that amount. The tax is a flat 40% tax of the fair market value of the transferred asset, and only the giver of the gift/inheritance is on the hook. But the giver only pays it when they exhaust the exemption amount, and only the amount in excess of the exemption is taxed. Additionally, only lifetime gifts in excess of the annual exclusion (currently $17,000 per year, per recipient) count against the exemption amount. If you never exceed the exemption amount, you don’t pay any tax.

That all being said, the exemption amount is set to reduce in roughly half (to ~$6,000,000 per person) on January 1, 2026, unless Congress acts. Keep your eyes peeled for the coming months and elections to see where the exemption amount lands.

Avoid the Estate Planning Banana Peel – Don’t Add Your Kids on Title to your Home

Many aspects of estate planning in California center around avoiding the need for probate court. Adding a death beneficiary to an asset or adding a co-owner on title to an asset are two ways to avoid the need for probate court when you die. Well, that sounds pretty easy. Why don’t we all just do that and call it a day?

Put simply, adding co-owners and death beneficiaries to assets only addresses one situation: that 1) you have died; 2) that the beneficiary/co-owner is alive upon your death; 3) the beneficiary/co-owner has capacity and is over 18 years old upon your death; and 4) the beneficiary/co-owner does not have creditors nipping at their heels.

There are so many other scenarios that can occur. All it takes is for any one of the four factors above to be false for your simple plan to become complicated and problematic. Besides that, there are tax implications for adding people onto title of your assets.

Let’s illustrate with a common example. A widowed parent owns their own home, and has two children. The parent figures that it would simplify everything if they add their two children onto the title of the home. That way, upon the parent’s death, the children receive the home, in equal shares, without having to go through the probate process.

What gets overlooked in the above hypothetical are the following considerations.

Death v. Incapacity

The only way to avoid probate in the above example is if the parent dies. If the parent is alive but incapacitated (think: dimentia), the children have no authority to act on the parent’s behalf by simply being co-owner of the home. They now co-own a property with someone who cannot handle their own affairs. They would have needed the parent to sign other legal documents, such as a durable power of attorney.

Similarly, if either or both children are incapacitated upon the parent’s death, probate may be necessary to receive ownership of the home unless the incapacitated child signed a durable power of attorney themself. Or, if the children are not yet adults, they cannot own the property outright without legal guardians involved.

Creditors

When the parent adds the children as co-owners to any asset, including their home, the parent is entangled with that child’s financial life, including that child’s creditors. If the child is going through a divorce, or someone is suing them for money, or the child owes taxes or other debts, or if the child files for bankruptcy, then the parent’s home is now subject to the claims of the child’s creditors. The parent may have to figure out how to get their own house back!

Additionally, if the child faces those same creditors after the parent’s death, there is no barrier between receiving full ownership of the house and satisfying those creditors’ claims. Ultimately, the child may end up losing the home to their creditors, which is certainly not what the parent intended.

Creating Capital Gains and Property Tax Problems (Click here for a brief discussion of taxes)

When the parent adds their children to title, the parent is making a lifetime gift of that portion of the home. This in itself could trigger a gift tax issue. Gift tax issues aside, typically when the parent dies, all of the capital gains built into the home are eliminated upon the parent’s death. But only the capital gains associated with the portion of the home that the parent owned at death. The portion of the home that the children now own do not receive what is called a “step up in basis”, and the capital gains for the children’s portion are not eliminated. If the parent kept all 100% interest in the home, then all of the capital gains would have been eliminated. After putting their children on title during their life, the parent is now creating a capital gains problem for the children when they sell the home.

Adding multiple children to title can also create adverse property tax implications. Even though Prop 19 has severely limited the application of the parent-child exclusion, there is still an opportunity for the parent to transfer the home to one or more children with some relief from increased property taxes. However, when more than one child is added as co-owner, the home could get reassessed when one child decides to buy another out in the future since that is not a parent-child transaction.

Co-ownership and death beneficiary designations lack any nuance. It only asks whether an owner is dead, and if the answer is yes, ownership of the asset automatically transfers to the other co-owners or to the beneficiaries in whatever condition or circumstance they find themselves. No discretion is involved to determine whether it’s a “good” situation to transfer ownership of the home to the co-owner or beneficiary. Additionally, It makes you vulnerable to your co-owners’ creditors, and could create unforeseen tax issues for your loved ones. The only surefire way to transfer ownership of your assets, with nuance and full discretion, is to create a comprehensive estate plan.

Taxes and Estate Planning

One of the most consistent questions that we come across involves taxes. For estate planning purposes, there are three (3) distinct types of taxes that may impact your estate plan. 

1. Estate & gift tax

The estate and gift taxes are transfer taxes. They are federal only. California does not impose an estate or gift tax.

• Transfer taxes tax the transfer of an asset. The estate tax is imposed when someone transfers something upon death (think: inheritance) and the gift tax is imposed when it’s a lifetime gift (think: birthday present).

• Who pays it? Always the person making the transfer (aka the estate of the person who died, or the person giving the gift). 

Not all transfers are taxed. There is an exemption amount that must be exceeded before the tax kicks in. The current exemption amount for an individual is $11.7 million*, and for a married couple it’s $23.4 million*. In other words, you need to have more than $11.7 million or $23.4 million in net assets to have to pay any estate tax. 

The gift tax is related to the estate tax. This is how: every year, every single person can give any other person $15,000* without reporting it to the IRS. A married couple can double that amount. If you exceed the amount, then you have to report it to the IRS. But instead of paying tax on it, your estate tax exemption amount is reduced by the fair market value of the item gifted. 

Example: If you love this blog, and you’re married, you can give Natasha $30,000 this year without reporting it to the IRS. If you love it SO much, you could give Natasha $31,000, but then you have to report that extra $1,000 to the IRS. The IRS then takes your $1,000 and reduces your estate tax exemption amount by $1,000. So instead of being $23.4 million exemption, it would be $23.4 million MINUS $1,000. 

*This is the amount for 2021. Each year this amount is adjusted for inflation. 

2. Income tax (capital gains taxes)

Income tax, as you know, is both state and federal. For purposes of this section, we’re focusing on capital gains taxes (profit made when selling something) and not your wage income (income made going to work).

If you buy something for an amount and it increases in value, and then you sell it, you have to pay taxes on that increase in value, which is called a gain. A capital gain is a profit from selling a capital asset, which is basically anything that is substantial in nature, excluding cash or retirement accounts (think: real estate, stocks, heavy machinery, artwork, collectibles, etc.). 

Example: You buy your house for $1 million. It increases in value to $4 million and you sell it. You’ve “earned” $3 million on the house. You have to pay capital gains taxes on the increase in value of $3 million. Your capital gains taxes are part of your income tax. 

Importantly, built-in capital gains get zeroed out when someone dies. 

Example: You buy your house for $1 million. It increases in value to $4 million, and you die. Whoever gets your house (spouse, child, etc.) retains it at the value of $4 million. If they sell it the minute that you died, then they do not pay any capital gains. If they hold on to it until it’s worth $10 million and sell it, then they would pay capital gains taxes based on $6 million in gains ($10 million - $4 million, date of death value), rather than $9 million ($10 million - $1 million, purchase price). 

3. Property tax 

Property tax is imposed by the county in which the property sits. We are bolding this because it’s important and has come up numerous times with Prop 19. To repeat: property tax is a COUNTY tax. It’s not state. It’s not federal. It’s local. 

Property tax is paid in two installments, annually. It is calculated based upon an “assessed value” and is only adjusted when a property is reassessed in value, which happens most often when it changes ownership on title. 

For the most part, property taxes are adjusted anytime the property changes hands, with certain exceptions. If you plan on transferring property to your children, or to your parents, then there are certain benefits afforded to these discrete transactions. Proper planning is critical to avoid unnecessary increases in property tax.

Why does this matter? 

It is crucial not to conflate or confuse the three taxes described above. Proper tax planning within the context of estate planning requires keeping each analysis separate. Tweaking a transaction to gain a benefit through one tax analysis may increase your tax exposure with one of the other taxes. Ultimately, you are best off planning ahead and trying to anticipate pitfalls before they happen, especially when it comes to intergenerational transfers. Contact us to discuss your specific situation and to work through your goals for your family.

Are You Married?

There is a common misconception that California honors “common law marriage” after seven years of living together.* 

*(The misconception sometimes has a different number of years associated with it.) 

In California, there is NO common law marriage. There is NO seven year rule (or any other year rule) to establish a marriage. The only way to be married in California is to marry with a state license and certificate from the county clerk. 

And if you’re not married, then under the law, you and your significant other have no more rights than roommates. 

There’s no legal in-between. 

If you live with your significant other for 50 years, you’re still not married. If you have children together, you’re still not married. If you share ownership of a home, you’re still not married. The only way to be considered married is to actually get married. 

So why is this significant? Well, in sum: married couples enjoy benefits that unmarried couples do not. Married couples are considered family (e.g. for visitation in a hospital, healthcare benefits, or even inheritance); they can own community property (which has its own benefits); and they have different tax treatments. 

A registered domestic partnership is also not marriage. Although California recognizes domestic partnerships, the federal government does not. The federal government only recognizes marriages. 

So that marriage certificate is not just a piece of paper. It has major consequences and impacts on your rights, benefits, and obligations. If you would like to discuss how your situation would be affected by getting married (or not), please contact us for a free consultation.

Are Holiday Gifts Taxable?

The short answer: Yup! But, spoiler: you probably won’t end up paying any gift taxes on holiday gifts.

A holiday gift is a donative transfer of an asset from one person (donor) to another (donee). A “donative transfer” simply means that the donee didn’t have to do or pay anything for it. It’s a true gift! It’s also a gift that you’re giving during life (intervivos) - as opposed to a gift that you make after you die (i.e. through a will or trust).

There is a tax that could be imposed, but that requires a little more explanation. Just like the government taxes things from your income (income taxes), to certain goods sold (sales tax), to real estate that you own (property taxes), it also taxes the transfer of items. So the gift tax is a transfer tax.

The gift tax is only imposed by the federal government (think: IRS); California doesn’t tax gifts. And it’s only imposed on the donor (the person giving the gift). If you receive a gift, and you live in California, you’re not on the hook for transfer taxes. If you give a gift, and you live in California, you still won’t owe any gift tax to the State of California and probably won’t owe any gift taxes to the federal government.

Here’s why: The federal government has this nifty rule called the “annual exclusion.” What that means is that each resident of the USA can make a gift up to $15,000, per year, to any other person, and not owe any taxes on that gift. In fact, the IRS doesn’t even want to know about it! You don’t have to report it. Married couples can combine that exclusion amount to $30,000 to one person, per year, and still fall within the same rule. So put another way, you’d have to be awfully generous this holiday season to have to deal with gift taxes.

Well, what if you are that generous?

If you make a gift in excess of $15,000 but less than what is called the exemption amount (currently $11.58 million per taxpayer for 2020; $11.7 million for 2021), you won’t owe any gift taxes. However, you do need to report it to the IRS. Once reported, the IRS will deduct the amount of the gift over $15,000 from your total exemption amount that you’re entitled to when you die. For example, if you give a $75,000 gift to your favorite niece this year, you would report a $60,000 gift ($75,000 - $15,000 exclusion amount) and the IRS would walk over to your file and deduct $60,000 from your $11.58 million unified credit. Only $11.52 million left to give before you pay transfer taxes! (The exemption amount involves estate taxes, which we can explain and discuss with you as part of your estate planning process.) 

Until then, may you have a safe, healthy, and generous holiday season!

Proposition 19

Californians have passed Proposition 19 with a little over 51% of the vote. It will significantly change the California property tax scheme as it applies to parent-child transactions.

There are two main components to Prop 19:

1. Over-55 Rule. The first component allows homeowners who are either over 55, have severe disabilities, or are victims of natural disasters or hazardous waste contamination to purchase a new residence and retain their property tax assessment from thier current home. In other words, you can “take” your current property tax rate with you to your next home, even if the new home is worth more than your current home. And you can do this up to 3 times in your lifetime. This provision takes effect on April 1, 2021.

1. Limited Parent-Child Exclusion. The second component dramatically limits what is called the “parent-child exclusion” from reassessment. Parents may no longer transfer unlimited amounts of property to children and escape reassessment. This one takes a bit more explanation. This provision takes effect on February 16, 2021.

A Brief Explanation of the Parent-Child Exclusion

In very broad terms, the California property tax scheme--or “Prop 13”--taxes owners of real property (the legal term for “real estate”) based on the property’s “assessed value.” To keep things simple, think of the “assessed value” as the purchase price of the property. Based on that purchase price, the tax collector imposes a ~1% tax. The property tax is not adjusted until or unless there is a “change in ownership.” When there is a change in ownership, the value of the property is reassessed. Reassessment can increase the property taxes dramatically for the new owner. 

In 1986, California voters allowed for an exception to the general “change in ownership” rule that triggers reassessment. The exception is that if parents transferred their property to their children (either by gift, inheritance, or sale), then the assessed value (i.e. property tax rate) would carry to the children. In other words, if you received property from your parents, you would continue to pay the property tax rate your parents were paying. This exception was unlimited when parents transferred their primary residence, and was limited in value when parents transferred property that was not their primary residence (e.g., vacation home, rental property, etc.).

Now let’s fast forward to February 16, 2021. When Prop 19 takes effect, the parent-child exclusion described above will be abolished. In its place will be a far more limited exception. The new exception only allows escaping reassessment if parents transfer property to their children AND the children use the transferred property as their primary residence. In other words, if the children do not live in the house and want to use it as a rental property (or keep it vacant) then the property will be reassessed. 

For example, if a parent bought a house in 1972 for $200,000, then their property tax might be $2,000 a year, regardless of the house’s increasing market value. If the parents transfer the home to a child (either gift, inheritance, or sale) after February 16, 2021, and the child does not live in the house, the property will be reassessed to its current fair market value (say $2,000,000) and the tax will jump to $20,000 a year.

Your Options Going Forward

There is no straight answer here. There are MANY unknowns at play here: the pandemic, a potential recession, other changes in the law in the near future, and particulars about your life and family. All that we know is that Prop 19 will dramatically change parent to child transfers going forward. If you were planning to leave your children property with the presumption that they would enjoy property tax savings, then you may want to consider transferring to them prior to February 2021. However, please understand that a lifetime transfer now may carry capital gains implications forward to your children. It’s a balancing act. We cannot emphasize this enough: there is no one-size-fits-all solution here. Contact us immediately to discuss your situation, things you can consider, and available options.

A side note on timing: The California election is not certified until December 11. After that, there will be regulations that are issued about how Prop 19 will be implemented and how it will work. While we can provide guidance at this point, there are still some questions outstanding that we won’t know the answers to until after that date.

What is... an ILIT?

This is part of an on-going series of blog posts titled the "What Is..." series, where we attempt to explain, in simple terms, common estate planning terms and concepts. To read other posts in this series, click here.

An ILIT (eye-lit) is an irrevocable life insurance trust. It’s a trust that cannot be changed (irrevocable) that is created to be both the owner and the beneficiary of a life insurance policy. Why would you do this? It’s a way of having life insurance proceeds excluded from a taxable estate. 

Remember that estate taxes are calculated by adding up the value of everything you own at your death, and if it’s over the estate tax exemption, your estate owes 40% of the excess over the exemption amount. Well, “everything you own at death” includes the proceeds of any life insurance policies you owned during life. Essentially, an ILIT allows you to gift the money “out” of your estate during your life, but still have control over the proceeds after you die.

If you’re thinking “what about gift taxes?” you’re on track: The trustee of the ILIT sends a letter to the ILIT’s beneficiaries (called a “Crummey” letter) every time you transfer money into the ILIT to pay for the insurance premiums. It advises the ILIT’s beneficiaries that they can ask for their share of the money within a specified period of time. 

Typically, no one actually asks for their share because the benefits of leaving it in the trust to pay life insurance premiums would result in more money, later. If there’s no money to pay the premium, then the policy will lapse and there won’t be anything for the beneficiary later. By issuing this letter, the money you transfer to the trustee of the ILIT becomes a “present interest” gift. In other words, that letter transforms your transfer of premium money into the trust into a lifetime gift that can be eligible for the gift tax annual exclusion. The annual exclusion allows you to make gifts up to $15,000 per year per person and not result in any gift taxes owed.

There are certain rules: 

1. You can’t be the trustee of the ILIT

2. Because it’s irrevocable, you fund it and you walk away. The trustee is in control of it. 

3. When the insured person dies, the trustee invests the insurance proceeds and administers the trust for the beneficiaries of the trust. 

The ILIT trustee possesses all incidents of ownership in the policy, so the ILIT can provide the insured’s estate with liquidity, while shielding the insurance proceeds or assets bought with the proceeds from estate tax when the insured dies. 

Flipped the other way: if you own the policy and retain control, you can withdraw cash or change beneficiaries as much as you want during your lifetime. This makes it YOUR asset. This also means that the IRS would include the proceeds of your policy in your estate’s value when you die. 

For example: the current exemption amount for an individual is $11.58 million . If you have $10 million in assets, and a $2 million life insurance policy that you control and maintain, then you have $12 million of taxable assets — over the current exemption amount. If, however, the $2 million insurance policy is in an ILIT, then it’s not part of your taxable assets, and you can (assuming it’s done correctly) stay below the exemption amount, and in this case avoid owing estate taxes.

An ILIT can either be funded with an existing life insurance policy, or the ILIT can purchase the policy on your behalf. If you opt to transfer an existing life insurance policy into an ILIT and you die within 3 years of that transfer, the IRS will still include the proceeds in your estate for tax purposes. If you have the ILIT purchase the life insurance policy, you can avoid this, but you must fund the trust with sufficient money over the years to pay the premiums. 

If you and/or your spouse are the chief breadwinner(s) of the household, and that income is abruptly diminished while your children are young and there are substantial monthly expenses, oftentimes families are challenged to make ends meet. For some clients, especially those with young children and who also have a substantial mortgage to pay, life insurance can be a useful tool to “inject” cash into an estate at an unexpected time of need to help pay for your child’s living expenses so that your children’s home would not need to be sold to defray costs.

Make sense? If not, contact us!

US Treasury Confirms No Clawback

The Tax Cuts and Jobs Act (“Trump Tax Law”) of 2017 increased the federal estate tax exemption from $5 million dollars per taxpayer to $10 million. That amount is effectively doubled for married couples. The exemption amount is indexed for inflation, meaning that it goes up incrementally every year. It is the exemption amount in the year that someone dies that is used to calculate estate taxes owed. For this year (2020), the exemption amount, with inflation, is $11.58 million per person, or $23.16 million for a married couple. In simple terms, if someone dies this year owning less than $11.58 million (whether things, homes, cash, etc.), then no federal estate taxes are owed. 

The estate tax (gifts at the time of death) exemption is linked to our gift tax system (gifts during life). The amount of lifetime gifts you give is added to the total amount of property you own when you die. For example, if George makes $5 million of gifts during his life, and then dies owning $7 million worth of property, then he would be on the hook for $12 million of gifts. That would use  his entire $11.58 million dollar exemption, and his estate would owe some estate taxes. I know, it’s a pretty good problem to have.

The Trump Tax Law provision elevating the estate tax exemption is set to sunset (expire) on January 1, 2026. If Congress does nothing between now and then, the exemption level will revert back to the $5 million amount, indexed for inflation. Essentially, the exemption will be cut in half if Congress does nothing.

So what happens if someone makes lifetime gifts in 2025, and then the exemption amount reverts back to the lower amount in 2026, and then the person dies thereafter? (To use the example above, George gives $5 million in 2025 and then dies in 2027 when the exemption amount is “only” $5 million, indexed for inflation.)

On November 26, 2019, the Treasury Department and the IRS issued final regulations adopting the regulations that were proposed in November of 2018, effectively ensuring that if a decedent uses the increased exclusion amount for gifts made while the Trump Tax Law is in effect and dies after the sunset of the Trump Tax Law, the decedent won’t be treated as having made taxable gifts in excess of his or her exclusion amount.

In plain English, this means that there won’t be a clawback if George uses the exclusion amount in effect now, even if the exclusion amount is lower when George dies.  For George, the IRS will use the greater of the exclusion amount used during the transfer or on the date of death. So George will not be penalized later even though the exemption amount dropped.

The final regulations also reinforce the notion of a “use it or lose it” benefit and direct that a taxpayer who uses the exemption is deemed to use the base $5 million (indexed) exemption first and then the additional amount of exemption available through 2025.  For individuals dying after 2025, if no gifts were made between 2018 and 2025 in excess of the basic federal exclusion amount in effect at the time of death, the additional exclusion amount is no longer available. In other words, unless George uses the increased exemption amounts before 2026, he will not receive that benefit later.

Either way, the exemption amounts cover a vast majority of American estates. However, for very high net worth families, we anticipate very large transfers of wealth to occur between now and 2026 so that the benefit of the heightened exemption amounts are not lost.

The SECURE Act

On December 20, 2019, President Trump signed the “Setting Every Community Up for Retirement Enhancement” (SECURE) Act into law. The SECURE Act, effective January 1, 2020, impacts people with retirement accounts.

There are three main ways that this impacts most people: 1) you will now be required to withdraw from retirement accounts at age 72 instead of 70 ½ ; 2) the Act removes age restrictions for contributions; and 3) any inherited retirement accounts will have a ten-year distribution limit for most people instead of the “lifetime stretch”. The SECURE Act does provide a few exceptions to this new mandatory ten-year withdrawal rule: spouses, beneficiaries who are not more than ten years younger than the account owner, the account owner’s children who have not reached the “age of majority,” disabled individuals, and chronically ill individuals.

Before the SECURE Act

Previously, any non-spouse beneficiary who inherited a retirement account was able to stretch out the required minimum distributions over his or her lifetime. Since the money was not taxed until it was distributed, it allowed beneficiaries to take minimum distributions, only pay income tax on that distribution, and defer paying income taxes on the balance of the inherited retirement account until actual distribution. 

After the SECURE Act 

Now, any non-spouse beneficiary is required to take all the distributions from the inherited IRA within 10 years. This means that the inherited retirement account will be taxed sooner and potentially at a higher rate over time. 

Spouse beneficiaries: If you inherit a retirement account from your spouse, nothing will change from the previous law. You will still be able to roll over the deceased spouse’s retirement accounts into your own.

Planning for the SECURE Act

For married couples who have retirement assets, and plan to leave any remaining retirement assets to the surviving spouse, the SECURE Act does not change much for you. Your spouse can still rollover any inherited retirement assets from you. For those who are either unmarried or are currently the surviving spouse, and you plan on leaving retirement assets to someone who is not your spouse, then this means that your beneficiaries will have a much shorter time (a maximum of 10 years) within which to distribute the funds in the inherited retirement account. This may result in triggering income tax sooner than expected, and perhaps additionally losing creditor protection.

Contact us to discuss whether your current estate plan is impacted by the SECURE Act.

Estate Planning for Noncitizen Spouses

Today, 44% of Californians were born out of the state. And the proportion of foreign-born residents (28%) is nearly double that of transplants from other states (16%). From an estate planning standpoint, the big-picture concepts hold true whether or not someone is born in California. Non-Californians own property just like Californians do. Similarly, most everyone has loved ones who they care for most, regardless of citizenship or residency.

However, tax treatment is different depending on one’s citizenship and residency. Complications arise when one or both spouses in a married couple are not U.S. citizens.

If you and/or your spouse are non-citizens of the United States, then two major concepts will play a role in your estate plan: 1) the Unlimited Marital Deduction; and 2) the Gift and Estate Tax Exemption.

1. Unlimited Marital Deduction
   Married citizen couples enjoy a tax benefit called the “unlimited marital deduction”. Citizen spouses can transfer property back and forth between each other⁠—lifetime gifts or transfers on death⁠—and it is never a taxable event. Non-citizen spouses do not get this benefit. If your spouse is not a U.S. citizen, and you give them a gift, then it is only tax-free up to $154,000 a year (in 2019). (This amount is indexed for inflation). For example, adding your non-citizen spouse onto the title of your family home could potentially become a taxable gift. Or upon the citizen spouse’s death, the non-citizen inherits all of the marital assets without the marital deduction. Thankfully, estate planners have techniques, like a Qualified Domestic Trust, to assist non-citizens avoid unnecessary taxable events.

2. Gift and Estate Tax Exemption
   Married couples who are both citizens, or if they are legal permanent residents (green card holders), are granted a unified gift and estate tax exemption. In plain terms, if citizens or green card holders transfer property in the amount of $11.4 million (in 2019) or less then no gift or estate taxes are owed. (This amount is also indexed for inflation). That amount includes all lifetime gifts with whatever you own at death. In large part, citizens do not need to worry about making transfers to their citizen spouses. However, non-citizens only receive a $60,000 exemption from the gift and estate tax. That’s not a typo. Leaving property to a non-citizen could result in a lot of estate taxes without proper planning. For more about the gift and estate tax, read our previous blog post.

Putting the above concepts to work, if spouses transfer property between each other, and the recipient spouse is a non-citizen, then the marital deduction is nonexistent, and the citizen spouse would have to employ their gift and estate tax exemption, if they have one, where they otherwise would not have to. Then later, if the non-citizen spouse passes property to any children, the non-citizen spouse would not have the gift and estate tax exemption a citizen spouse would have. The result could be an avoidable disaster.

Non-citizens largely have the same desires and wishes that citizens have. Their legal status is merely different than that of citizens. However, that legal distinction does create challenges for which a plan is necessary. Do not leave your loved ones with an undesired mess. Get ahead of the issues by planning now.

Are Holiday Gifts Subject to the Gift Tax?

The short answer: yup! But the more nuanced answer is that if you are giving a gift or receiving a gift in California, you probably won’t end up paying any gift taxes on holiday gifts.

Let’s take a look at the mechanics of a holiday gift. Without getting overly complicated, a holiday gift is a donative transfer of an asset from one person (donor) to another (donee). A “donative transfer” simply means that no one traded you or paid you anything for it (as in, it’s a true gift). Just like the government taxes your income (income taxes), certain goods sold (sales tax), and also real estate that you own (property taxes), it also taxes the donative transfer of assets. So the gift tax is a transfer tax.

A couple of details: the gift tax is only imposed by the federal government--so only the IRS will tax you, not the state of California--and it’s only imposed on the donor (the person giving the gift). If you receive a gift, and you live in California, you’re not on the hook for transfer taxes.

There are two types of gifts: those you give during life (intervivos) and those you make after you die (like through a will or trust). We’re going to focus on intervivos gifts since most holiday gifts are given during life.

Here’s why most of you will not owe any gift taxes on your holiday gifts. The federal government has this nifty rule called the “annual exclusion”. What that means is that each of you can make a gift up to $15,000, per year, per recipient, and not owe any taxes on that gift. In fact, the IRS doesn’t even want to know about it! You don’t have to report it. Married couples can combine that exclusion amount to $30,000 to one recipient, per year, and still fall within the same rule. So put another way, you’d have to be awfully generous this holiday season to have to deal with gift taxes.

Well, what if you are that generous? What happens if you make a gift that exceeds the annual exclusion?

Now we get to the “unified credit” or estate tax exemption amount. The unified credit is an amount the federal government allows you to gift during your entire lifetime, and combine that amount with whatever you own when you die, and not pay any transfer taxes if you are below the unified credit amount. It’s an amount set by law, and it increases every year based on inflation. The credit amount in the year that you die is what is applied. The exemption level for 2018 is $11.18 million. For example, let’s say you die in 2018 (sorry to bum you out!)--if the total of what you gifted during your life, and what you owned at death is less than $11.18 million then you would pay ZERO transfer taxes. For 2019, that number increases to $11.4 million.

Let’s recap: if you make a gift to someone that’s valued at $15,000 or less, per person, you don’t have to report it, and no transfer taxes are owed, and there’s no reduction in your unified credit amount. If you make a gift in excess of $15,000 but less than the unified credit (currently $11.18 million), you won’t owe any transfer taxes, but you’ll need to report it to the IRS. They’ll walk over to your file, and deduct the amount of the gift from your unified credit amount. For example, if you gift $20,000 to your favorite niece this year, you would report a $5,000 gift ($20,000 - $15,000 exclusion amount) and the IRS would walk over to your file and deduct $5,000 from your $11.18 million unified credit. Only $11.175 million left to give before you pay transfer taxes!

Happy Holidays! And don’t forget to send those ‘thank you’ cards!