ESTATE PLANNING: Estate Taxes I: An Introduction to Estate and Gift Taxes for the Maine Resident

One of the oldest and most common forms of taxation is the taxation of assets held by an individual at the time of death. "Death tax" is a general term that includes estate taxes and inheritance taxes. Estate taxes are levied on a decedent's estate before any transfers while inheritance taxes are levied on the people who receive assets from a decedent's estate. For Maine residents, there is both a federal estate tax and a Maine estate tax, and the amount exempt from federal estate tax is different from the amount exempt from the Maine estate tax. Maine does not have an inheritance tax.
 

Exemptions from Federal and Maine Estate Tax
 

An estate tax return must be filed for a decedent's estate only if the value of the decedent's gross estate exceeds the applicable exclusion amount. This is the amount that is exempt from estate tax. The most significant change in federal estate taxes in the last decade has been the increase in the federal exemption amount. The result is that the federal estate tax applies to fewer and fewer individuals.

Under the Economic Growth and Tax Relief Reconciliation Act of 2001 (Tax Act of 2001), the value of total transfers that are exempt from federal estate tax increase dramatically through 2009. For individuals who die in the following years, the property sheltered by the federal exemption amount is shown:

2001 — $675,000

2002 and 2003 — $1,000,000

2004 and 2005 — $1,500,000

2006, 2007, and 2008 — $2,000,000

2009 — $3,500,000

2010 — estate tax is repealed

The Tax Act of 2001 is repealed in 2010. Unless Congress takes action to keep the provisions of the Tax Act of 2001, the amount exempt from federal estate tax in the year 2011 and thereafter will be $1 million.
 

Another result of the federal Tax Act of 2001 for Mainers has been the "decoupling" of the Maine estate tax from the federal estate tax. The Maine exemption amounts are considerably lower than the federal exemption amounts for federal estate tax. For decedents dying in 2005, the exemption is $950,000. In 2006 and thereafter, the exemption amount is only $1 million.

The difference in the federal and the Maine exemption amounts results in a "gap" for certain decedent's estates: a Maine estate tax may be levied on the estate even though no federal estate tax is due. And for many estates, the best estate plan will now be based on the Maine exemption amount rather than on the federal exemption amount.

Below is a table of federal and Maine estate tax liability for 2005 for estates without adjusted taxable gifts:

 
As suggested by this chart, the number of estates that will be exposed to the Maine estate tax but will avoid federal estate tax will increase as the federal exemption amount continues to increase (at least under current tax law) while the Maine estate tax remains level at $1 million.
 

Calculating Exposure to Estate Tax
 

In the case of both the federal estate tax and the Maine estate tax, the starting point in assessing estate tax liability is determining the gross estate. This encompasses all property in which a decedent had an interest on the date of death. The taxable gross estate includes the property distributed by a will or a living trust but also includes assets like retirement accounts, certain trusts and jointly owned property.
 

Stocks, bonds, tangible personal property, real property, mortgages, notes and lifetime transfers which are revocable or in which the decedent retained interest are all included in the gross estate. Property over which the decedent had a power of appointment and some lifetime transfers made by the decedent within 3 years of death are also included. The proceeds of life insurance are included in the gross estate if the policies were owned or controlled by the decedent.
 

The gross estate is reduced by:
 

(1) funeral expenses, administration expenses, debts and any casualty losses during estate administration not compensated for by insurance;
 

(2) the charitable deduction for transfers to qualified charitable organizations; and
 

(3) the marital deduction for property passing to a spouse.
 

For couples seeking to minimize the exposure of their wealth to estate taxes, it is essential that the estates of both spouses take advantage of the shields provided by the unlimited marital deduction and each spouse's respective applicable exclusion amounts. See our article titled "Maximizing Estate Tax Savings for a Married Couple with Credit Shelter Trusts."
 

Any individual seeking to minimize exposure to estate taxes - whether single or married -should consider lifetime gifts.
 

Gift Tax
 

Any donor who makes large lifetime gifts should recognize the possible exposure to the federal gift tax. Like the estate tax, there is an applicable exclusion amount for gifts made during life. Under the Tax Act of 2001, the lifetime amount exempt from gift taxes increased to $1 million. However, unlike the estate tax, this amount will not increase further, and the gift tax is not repealed in 2010.
 

The gift tax is not actually payable unless the aggregate of all taxable gifts made by a donor during life exceeds $1 million. But to the extent the gift tax credit is used during life, it is not available to the donor's estate after the donor's death. At the same time, any gift tax actually paid during life is offset against the federal estate tax payable on the decedent's death.
 

Taxable gifts are defined as the total amount of gifts made in a calendar year, less allowable exclusions and deductions.
 

1. Unlimited Charitable Gift Deduction

When a gift is made to a qualified charity during the donor's lifetime, it is deductible for gift tax purposes; if made at the donor's death, it is deductible for estate tax purposes. A "qualified" charity includes charities operated exclusively for religious, scientific, literary, or educational purposes as well as groups that aid or prevent cruelty to children or animals, fraternal organizations and national, state or local government units.
 

No gift tax return needs to be filed for an outright gift to a charity.
 

2. Annual Exclusion Gifts

Individuals who are planning to minimize estate taxes often utilize the annual exclusion deduction, formerly set at $10,000 and is now adjusted for inflation. In 2004, a donor may exclude up to $11,000 per person annually from the gift tax for gifts to as many different donees as the donor chooses.

The exclusion is only allowed for present-interest gifts, that is, gifts of assets for which the immediate use of the asset is available to the donee. Also, the annual exclusion is only available for gifts to individuals.
 

When making gifts to individuals, it is important to consider the capital gains consequences and to understand the difference between carryover basis and step-up in basis.
 

The recipient of a lifetime gift receives a "carryover basis." This means that the cost basis of the donee is the same as the cost basis of the donor. Therefore, when the donee sells assets that appreciated in value while owned by the donor, the donee must pay capital gains tax on that appreciation (in addition to any appreciation while owned by the donee). Often, the best strategy is for a donor to transfer unappreciated assets to the donee, and reserve appreciated assets for herself.

Assets forming a part of the estate of a decedent are included in that person's estate for federal estate tax purposes. The beneficiary of the estate receives a "step-up" in basis with respect to those assets so that the beneficiary's new basis is the fair market value of the assets as of the date of the death of the decedent. The step-up in basis can be very beneficial to donees.
 

When choosing which assets to gift, it may be helpful to have input from an accountant.
 

3. Medical and Tuition Payments

Payments made to defray another person's medical expenses are excludable for gift tax purposes. Also excludable are tuition payments made on behalf of another. In both cases, to qualify for this exclusion the payments must be made directly to the health care provider or the educational institution.