Federal and State Gift and Estate Taxes

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1 E s t a t e P l a n n i n g I N N O R T H C A R O L I N A Federal and State Gift and Estate Taxes Learn about federal gift and estate taxes what they are, how they are calculated, and how they may be avoided or reduced. Distributed in furtherance of the Acts of Congress of May 8 and June 30, North Carolina State University and North Carolina A&T State University commit themselves to positive action to secure equal opportunity regardless of race, color, creed, national origin, religion, sex, age, veteran status or disability. In addition, the two Universities welcome all persons without regard to sexual orientation. North Carolina State University, North Carolina A&T State University, U.S. Department of Agriculture, and local governments cooperating. Although the gift tax and the estate tax are separate taxes, both the federal and state rules that govern them are interrelated. By using the rules wisely, you can reduce or eliminate federal estate tax liability. Additional taxes may affect your estate plan, including the North Carolina gift tax, estate tax, and other taxes. Who Needs Tax Planning? You may need tax planning depending on how much you own, how much you give away each year, or both. If what you own is worth more than $2 million (applies only to deaths in 2006 through 2008), you may benefit from tax planning. If what you give away is worth more than $12,000 per year per person, you also may benefit from tax planning. Tax planning maximizes the use of credits, deductions, exemptions and exclusions allowed under the gift and estate (transfer) tax laws. Tax planning requires knowledge of some basic concepts, federal estate and gift tax legislation, and state tax laws. Basic Concepts and Terms Transfer taxes. The federal government taxes the transfer of property between individuals. All property is subject to transfer taxes, including real property (real estate) and personal property, such as bank accounts, jewelry, cars, cash, stocks and bonds. If you give away property during your lifetime, you may be liable for gift tax. If you transfer property at your death, your estate may be liable for estate tax. Gift and estate taxes are called transfer taxes because the tax is on the transfer of real and personal property. Unified estate and gift tax. Transfers of property, either during your lifetime or at death, are taxed under a single taxation scheme the unified estate and gift tax. The term unified means single. A single tax rate schedule applies to both gift and estate taxes. A single credit also applies to both taxes. The rules are interrelated, so that gift tax liability incurred during your lifetime can affect your estate tax liability. Note that the Economic Growth and Tax Relief Reconciliation Act of 2001 partially decoupled the estate and gift tax, making the calculation of whether to make a lifetime gift or a transfer at death more complicated. Unified credit. A unified credit is an applicable credit amount that exempts a certain amount of property from taxes on gifts made during lifetime or on estates passing at death. The unified credit can be used only once, either during life to offset gifts or at death to offset the calculated federal estate tax. If you make large gifts during your lifetime, you may use the unified credit to avoid owing gift tax. Any unified credit amount that you use against your gift tax in one year reduces the amount of credit that you can use against your gift tax in a later year. To the extent that you use the credit during your lifetime, it will not be available to your estate at your death. Ask your lawyer for advice before making large gifts. Federal Tax Rates and Exemptions Based on the size of an estate or a gift, certain estate and gift tax rates apply. The Internal Revenue Code also allows exemptions on these taxes up to certain limits. With the passage of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), the applicable estate tax exemption amount increases until the estate tax is repealed in Table 1 shows the amount of property sheltered by the applicable exemption amount along with the applicable unified credit amount for estates settled between 2001 and To better understand a unified credit, see the Basic Concepts and

2 Terms section. In 2011, the Act sunsets and estate tax reappears with the applicable exemption amounts reverting to the 2002 levels unless Congress extends the Act s provisions. Prior to the passage of EGTRRA, estates larger than $10 million lost the benefit of a unified credit. This cap is not applicable while EGTRRA is in force. In 2011, however, when the Act sunsets, the unified credit cap may be enforced again unless Congress decides otherwise. These provisions are not applicable for exemptions on gifts that have consistently remained at $1 million with a unified credit amount of $345,800 over these years. The gift tax rates are the same as the rates for the estate tax, except in 2010 when the maximum gift tax rate is 35 percent. Any unified credit amount used to offset gift tax due will reduce the unified credit amount available to offset estate tax. Table 1. Revised Estate Tax Exemptions and Unified Credit Economic Growth and Tax Relief Reconciliation Act of 2001 Year Exemption Equivalent Unified Credit 2001 $675,000 $220, $1,000,000 $345, $1,500,000 $555, $2,000,000 $780, $3,500,000 $1,455, Repealed $ $1,000,000 $345,800 Unified rate schedule. If a property transfer is subject to federal tax, the tax is determined using the unified rate schedule. It applies to both gift and estate taxes. The tax rate is based on cumulative (total) transfers. Thus, the value of property you transferred in the past may push your current transfers by gift and transfers at death into a higher tax bracket. The tax rates are graduated: the lower tax rates apply to transfers of property of low value, and higher rates apply to transfers of high value. Remember, by 2011 when estate taxes are repealed, the benefits of the graduated rates may be phased out for cumulative transfers exceeding $10 million, as was the case before EGTRRA was passed. You can determine your potential gift or estate tax using the rate schedule listed in Table 2. Before 2007, additional tax brackets applied for amounts greater than $2 million with marginal rates up to 55 percent. After the 2001 passage of EGTRRA, the applicable estate tax rates have consistently decreased and will do so until the Act is repealed completely in 2010 (see Table 3). Transfers between spouses. Transfers of property between spouses are generally not subject to federal gift or estate tax. The marital deduction allows you to transfer an unlimited amount of property to your spouse during your lifetime or at your death free of transfer taxes. Certain transfers between spouses, however, may not qualify for the marital deduction. For example, if you give Table 2. Gift and Estate Tax Rate Schedule (as in 2007) Value of Property Transferred More Than But Not More Than Tax Amount and Rate Tax on Amount in Column 1 Rate of Tax on Excess of Amount in Column 1 Column 1 Column 2 Column 3 Column 4 $0 $10,000 18% $10,000 $20,000 $1,800 20% $20,000 $40,000 $3,800 22% $40,000 $60,000 $8,200 24% $60,000 $80,000 $13,000 26% $80,000 $100,000 $18,200 28% $100,000 $150,000 $23,300 30% $150,000 $250,000 $38,800 32% $250,000 $500,000 $70,800 34% $500,000 $750,000 $155,800 37% $750,000 $1,000,000 $248,300 39% $1,000,000 $1,250,000 $345,800 41% $1,250,000 $1,500,000 $448,300 43% $1,500,000 $2,000,000 $555,800 45% $2,000,000 $780,800 45% Table 3. Revised Estate Tax Rates and Associated Exemptions Economic Growth and Tax Relief Reconciliation Act of 2001 Year Exemption Equivalent Maximum Tax Rate 2001 $675,000 55% 2002 $1,000,000 50% 2003 $1,000,000 49% 2004 $1,500,000 48% 2005 $1,500,000 47% 2006 $2,000,000 46% 2007 $2,000,000 45% 2008 $2,000,000 45% 2009 $3,500,000 45% 2010 Estate Tax Repealed 0% 2011 $1,000,000 55% your spouse the right to use and possess the property for his or her lifetime, with the property going to your children at your spouse s death, this transfer does not qualify for the marital deduction. Some temporary interests may qualify for the marital deduction if properly designed. For example, the widely used qualified terminable interest property (QTIP) trust permits a surviving spouse to use property while deferring taxes until the property is received by the ultimate beneficiaries, usually the couple s children. 2

3 Federal Gift Tax The federal gift tax is a tax on transfers of property made as gifts. A gift is a lifetime transfer of property from one person (the donor) to another (the donee) where the donor does not receive anything of equivalent value in return. A gift must fulfill three requirements: The donor must intend to make a gift. The donor must deliver the gift. The donee must accept the gift. Before gift tax can be imposed, the gift must be completed. A promise to make a gift is not enough. The gift must be delivered and accepted. The donor must give up all control over the property. If the donor has the right to give the property to someone else or to take the property back, the gift is not completed. How gifts are valued. Generally, the gift s value is its fair market value on the date it is given. The gift s value may be less than fair market value to the extent that the recipient (the donee) gives the donor something in return. E x a m p l e 1 Father sells Son a house for $1. If the fair market value of the house is $100,000, Father has made a gift to Son valued at $99,999. Under some circumstances, a gift may be valued higher than its fair market value. This can occur when the donor retains certain rights in the property. Gift tax may be imposed on the entire property s value, including the value of the rights kept by the donor. This rule applies to transfers of property made after October 8, Before that date, gift tax was imposed only on the value of the property given away. Properly structured gifts can avoid this problem. Ask your attorney for more information. The annual exclusion. A taxpayer may give $12,000 per year (in 2008) per donee without incurring federal gift tax liability. This amount is called the annual exclusion. The annual exclusion amount is indexed for inflation. If the donee will receive the gift s benefits in the future, it is a gift of future interest and the annual exclusion does not apply. E x a m p l e 2 Mother transfers property valued at $12,000 to a trust for the benefit of Son. The trust is irrevocable. The gift is completed because Mother cannot change the terms of the trust. Son will receive one-half of the property placed in the trust when he reaches age 21 and the other half when he reaches age 35. Because Son does not receive the benefits of the gift until sometime in the future, it is a gift of future interest. The annual exclusion does not apply, and the gift may be subject to gift tax. Note that some gifts to minor children may qualify for the annual exclusion even if the minor children will receive the benefits in the future. The gifts must be properly structured. Ask your attorney for more information. A husband and wife may choose to split gifts. Each spouse is considered to give one-half of the gift, regardless of which spouse owned the property. Thus, a husband and wife may double the annual exclusion to $24,000 per year per donee. Computing the gift tax. The gift tax is computed on gifts in excess of the annual exclusion amount using the following formula: 1. Determine the value of all gifts made during the year. 2. Subtract allowable exclusions, such as payments made directly to a provider for medical expenses or tuition. 3. Subtract allowable deductions, such as discounts for holding a minority interest or an interest subject to sales restrictions in a company or jointly-owned real estate. 4. Add the value of all prior taxable gifts. (Remember that the estate and gift tax rate is based on cumulative transfers. Prior gifts push the current year s gifts into higher tax brackets. The gift tax paid on prior taxable gifts is subtracted in Step 6.) 5. Apply the unified estate and gift tax rates. See the unified rate schedule for the applicable rate of tax. 6. Subtract the amount of gift taxes paid on prior taxable gifts. 7. Subtract the allowable unified credit. The result is the amount of gift tax owed for the calendar year. Allowable exclusions may reduce or eliminate the amount of gift tax. As discussed, the annual exclusion exempts gifts of present interest valued at $12,000 or less per donee from gift tax each year. The educational and medical expense exclusion exempts an unlimited amount paid directly to educational organizations for tuition and to health care providers for medical services. Deductions may reduce or eliminate the amount of gift tax owed. The deductions are taken after the allowable exclusions are subtracted. A deduction is available for transfers made to charitable, public, and religious organizations. The marital deduction exempts property transferred to a spouse. Gift tax returns. The donor files a gift tax return to report gifts of present and future interest. Gift tax returns should be filed, and any gift tax due should be paid each year. When a gift tax return is filed, a statute of limitations begins and runs generally for three to six years after filing, depending on the amount of unreported items. Generally, the gift tax return is due by April 15. Donors do not need to file a gift tax return under the following circumstances: When gifts of present interest to any donee are valued at $12,000 or less for the year. Spouses who split gifts must file a gift tax return. If the split gift is $24,000 or less, they may file a short-form gift tax return. When qualified transfers are made directly to educational organizations for tuition and to health care providers for 3

4 medical services. When transfers are made to a spouse that qualify for the marital deduction. Interest and penalties. If the gift tax is not paid when due, interest and penalties may be assessed. Interest on the unpaid amount is compounded daily. Failure to file a return is also subject to penalties. If you willfully fail to file a required gift tax return or to pay gift tax due, you may be subject to criminal penalties, including fines and imprisonment. Federal Estate Tax The federal estate tax is a tax on the transfer of property at death. It is computed using the following formula: 1. Determine the value of the gross estate. 2. Subtract allowable deductions. 3. Add the value of taxable gifts made after 1976 if not already included in the gross estate. (Remember that the estate and gift tax rate is based on cumulative transfers. The gift tax paid on taxable gifts made after 1976 is subtracted in Step 5.) 4. Apply the unified estate and gift tax rates. See the unified rate schedule for the applicable rate of tax. 5. Subtract the amount of gift taxes paid on taxable gifts made after Subtract the allowable unified credit and other allowable credits. The resulting amount is the net federal estate tax owed by the estate. Gross estate. The gross estate is the total value of all interests in property owned by the decedent at his or her death. It also may include the value of some property transferred during his or her life. Some special types of property are discussed in the following sections. For a complete discussion of the property interests that may be included in your gross estate, consult your attorney. Property transferred with retained interests. Property transferred during a decedent s life may be added to his gross estate if he continues to hold rights in the property. E x a m p l e 3 Mother transfers her house to Son but keeps the right to use and possess the house for her lifetime. The value of the house will be included in her gross estate. Later, if Mother gives up her rights in the property, she may be able to exclude its value from her gross estate. To do so successfully, she must give up her rights more than three years before her death. If she gives up her rights within three years of death, the value of the house will be included in her gross estate. Note that this example does not discuss possible gift tax liability. Jointly owned property. Special estate tax rules apply to property that the decedent owned jointly with others. This depends upon the type of joint interest: 1. Without a right of survivorship. If the decedent owned the property as a tenant in common (no right of survivorship), only the value of the decedent s fractional interest is included in the gross estate. E x a m p l e 4 John and his three sisters own a parcel of land valued at $100,000. The four are equal owners. When John dies, the value of his interest, $25,000, will be included in his gross estate. 2. With a right of survivorship. Rules for property owned with a right of survivorship are different depending upon who owned the property with the decedent. If the co-owner was the decedent s spouse, only one-half the value of the property is included in the decedent s gross estate. E x a m p l e 5 John and Mary Smith own their home as tenants by the entireties (with a right of survivorship). The home was purchased with Mary s money in If Mary dies, only one-half of the value of the home will be included in her gross estate. The rule for property owned by spouses may be the same as for nonspouse co-owners, discussed next, if they owned the property before This question is currently open to debate. Application of the nonspouse rule may have tax benefits for the surviving spouse. Ask your attorney or accountant for details. If the co-owner was not the decedent s spouse, the entire value of the property may be included in the decedent s gross estate. However, the value included in the decedent s gross estate is reduced by the amount contributed by the co-owner. E x a m p l e 6 Jane and her daughter Sue jointly own a bank account with deposits totaling $100,000. When Jane dies, the entire $100,000 will be included in her gross estate. However, if Jane s estate can show that Sue contributed $25,000 to the account, only $75,000 will be included in Jane s gross estate. The exception to this rule is when the decedent and tbe co-owner acquired the property by gift or inheritance. Then, the value of the decedent s fractional share is included in his or her gross estate. Life insurance proceeds. Proceeds of life insurance policies on the decedent s life may be included in his or her gross estate in two situations: The life insurance proceeds are payable to the decedent s estate, or to the executor or other person for the benefit of the estate. 4

5 The decedent owned the policy or held rights of ownership in the policy at death or within three years of death. The proceeds may be excluded from the gross estate in this situation if the insured gives up all rights of ownership in the policy at least three years before death. Ask your attorney for details. Valuing property included in the gross estate. Property is valued at the fair market value on the date of death. Alternatively, the executor may elect to value the property six months after the date of death. An appraisal is often used to set the property s value. If the estate s representative and the Internal Revenue Service differ on the value, a court may have to decide the appropriate value. Allowable deductions. The following items may qualify as deductions from the gross estate: Funeral expenses. Expenses of administering the estate. Losses due to casualty or theft if the losses occur during the administration of the estate and are not covered by insurance. Claims against the estate. Mortgages and other indebtedness. Taxes owed but unpaid on the date of death. The value of property transferred to the government or to tax-exempt charitable, religious, educational or similar organizations. The value of property passing to the surviving spouse (all property passed to the surviving spouse, without a reservation of rights, is deductible). Allowable credits. The following credits may reduce the amount of estate tax owed: The applicable unified credit amount for 2007 and 2008 is $780,800 and exempts $2,000,000 worth of property from federal estate tax. A credit is available for federal gift taxes paid by the decedent on taxable gifts made before 1977 to the extent the value of the gift is included in the gross estate. A credit is available, with limitations, for estate taxes paid to a foreign country on property included in the gross estate. A credit is available, with limitations, for property that has been subject to federal estate tax in another decedent s estate within ten years of death. Estate tax returns. The federal estate tax return is due within nine months after the date of death. Generally, the decedent s representative must file an estate tax return if the value of the gross estate exceeds $2 million. However, if a unified credit has been used to offset lifetime gifts, the estate s value would be less. Some other factors, such as life insurance on the decedent that was not owned by the decedent, may trigger a filing requirement for some gross estates of less than $2 million. Interest and penalties. If the tax is not paid when due, interest and penalties may be assessed against the estate. Interest on the unpaid tax is compounded daily. Penalties that may be imposed against the estate include penalties for late filing and late payment, for undervaluing the estate property, and for fraud. Criminal penalties that may be assessed include fines and imprisonment. Additional Federal Taxes Generation skipping transfer tax. The generation skipping transfer (GST) tax is a tax on property transfers at death. It is added to the federal estate and gift taxes for skips that exceed the GST exemption. The GST exemption amount is equal to the unified credit amount under current law. However, it is applied independently only to skips, not the entire estate. To discourage families from attempting to avoid estate taxes at the deaths of one or more generations by using multi-generation trusts, Congress created the GST tax. Generally, the GST tax applies to situations where a generation that would logically receive property at a death is skipped. If you plan to make large gifts to grandchildren or other future generations, or if your grandchildren may benefit under your estate plan, ask your lawyer or accountant whether your plans may subject you or your estate to the GST tax. Excess retirement accumulation tax. An additional 15 percent tax is imposed on the estate of any person who dies with excess qualified retirement accumulations. This tax is independent of the estate tax and is calculated separately. Estate tax credits, deductions, and exclusions do not reduce this tax. If this tax applies, the decedent s representative must file an estate tax return regardless of the gross estate value. If you have large amounts of retirement savings in qualified retirement plans, annuity plans, tax-sheltered annuities, and IRAs, check with your attorney or accountant to see if you or your estate may be subject to this tax. The rules discussed in this publication apply only to U.S. citizens. Some of the rules are different for non-u.s. citizens. If you are a non-u.s. citizen, check with an attorney or an accountant for more information. North Carolina Gift Tax The state levies a gift tax on property given to another individual during one s life. Since 2006, the amount of annual exclusion has been increased to $12,000. This annual exclusion does not apply to gifts that do not take effect until a future time, unless the gift is made to someone less than age 21 and certain conditions are met. A spouse may use the other spouse s annual exclusion to make a gift valued at up to $24,000 in one year to one person. Both spouses must be residents of North Carolina. For the latest information about the annual gift tax exclusion, refer to the Web sites listed under Other Resources North Carolina Gift Taxes. Lifetime exemption. In addition to being able to give $12,000 per year per recipient free of gift tax, donors have a lifetime state exemption of $100,000 (in contrast to the $1 million exempt under the federal gift tax) that shelters gifts 5

6 made to certain close relatives, such as children and parents. This exemption can be used entirely in one year or stretched over the lifetime of the donor. In years when individual gifts exceed $12,000, the excess can be applied against the $100,000 exemption until it is used up. This exemption can be claimed by a donor only if the donee is a direct descendant, ancestor, adopted child, or stepchild. Other exemptions. North Carolina does not impose a gift tax on gifts made to some entities: a spouse; charitable, educational, or religious organizations located within North Carolina, or located in another state if that state does not tax its residents for gifts made to such organizations located in North Carolina; or the state of North Carolina or to counties or municipalities within North Carolina. North Carolina gift tax also does not apply to certain other payments: tuition payments made on behalf of an individual to an educational institution; medical payments made on behalf of an individual to a provider of medical care; property transferred to a spouse that qualifies under federal law as terminal interest property; and Qualified Tuition Programs. Tax rates. The N.C. gift tax rates are listed in Table 4. Rates start at zero with the $100,000 exemption applied as an equivalent credit. Different tax rates apply to gifts made to Class A, B, or C beneficiaries. Class A beneficiaries are parents, children, and grandchildren, whereas Classes B and C include other relatives and nonfamily members. Gifts sheltered by the $12,000 annual exclusion or the $100,000 lifetime exemption are not taxable gifts. (Refer to www. dornc.com/taxes for the latest information.) You must prepare a state gift tax return for any calendar year in which you made gifts of more than $12,000 to an individual donee. This return is to be filed and tax paid, if due, by April 15 following the calendar year in which the gift was made. North Carolina Estate Tax North Carolina imposes an estate tax on the estate of a decedent when a federal estate tax is imposed on the estate and the decedent was either (1) a resident of North Carolina or (2) a nonresident who owned real property in North Carolina or personal property located in North Carolina for tax purposes. Prior to the enactment of the 2001 EGTRRA, the federal tax rules allowed a state death-tax credit against the amount of federal estate tax owed on estates. The credit amount was determined under a federal formula, and the amount of federal tax was reduced by the credit amount. The credit effectively gave states a part of the estate tax revenue that was otherwise payable to the federal government. Following EGTRRA, this state death tax credit was to be phased out over three years beginning in The federal government would no longer share its estate tax revenue with the states. North Carolina, however, like many other states, did not adopt the federal phase-out or termination of the credit. Therefore, North Carolina estate tax is equal to the pre-enactment state death-tax credit level. The result is that estates have to pay the full amount of the federal tax as well as the full amount of the former state death-tax credit. North Carolina estate tax is payable from the estate s assets. A person who receives property from an estate is liable for the amount of estate tax attributable to that property. The personal representative of an estate is liable for any estate Table 4. North Carolina Gift Tax Rates for Class A Beneficiaries* If the taxable gift is: Not over $10,000 1% The tax rate is: Over $10,000 but not over $25,000 $100 plus 2% of amount over $10,000 Over $25,000 but not over $50,000 $400 plus 3% of amount over $25,000 Over $50,000 but not over $100,000 $1,150 plus 4% of amount over $50,000 Over $100,000 but not over $200,000 $3,150 plus 5% of amount over $100,000 Over $200,000 but not over $500,000 $8,150 plus 6% of amount over $200,000 Over $500,000 but not over $1,000,000 $26,150 plus 7% of amount over $500,000 Over $1,000,000 but not over $1,500,000 $61,150 plus 8% of amount over $1,000,000 Over $1,500,000 but not over $2,000,000 $101,150 plus 9% of amount over $1,500,000 Over $2,000,000 but not over $2,500,000 $146,150 plus 10% of amount over $2,000,000 Over $2,500,000 but not over $3,000,000 $196,150 plus 11% of amount over $2,500,000 Over $3,000,000 $251,150 plus 12% of amount over $3,000,000 *Class A beneficiaries are the donor s parents, children or grandchildren, adopted children, and in certain cases, sons- and daughters-in-law. Gifts made to Class B beneficiaries (brothers, sisters, descendants of brothers and sisters, or uncle or aunts by blood) are taxed at rates ranging from 4% to 16%. Gifts made to Class C beneficiaries (all others) are taxed at rates ranging from 8% to 17%. 6

7 tax not paid within two years after it is due. This liability is limited to the value of the estate s assets under the personal representative s control. The personal representative may sell estate assets to obtain money to pay the estate tax. The state estate tax is due when an estate tax return is due, which is the date a federal estate tax return is due. A North Carolina estate tax return must be filed if a federal estate tax return is required. North Carolina Generation-skipping Transfer Tax The U.S. generation-skipping transfer tax imposes a tax on gifts or transfers in trust to persons two or more generations younger than the donor, such as grandchildren. Such a tax is imposed only if the transfer avoids incurring a gift or estate tax at each generation. North Carolina imposes a generationskipping transfer tax when such a tax is imposed under federal law if any of the following apply: The donor is a resident of North Carolina at the time of the original gift. The donor is not a resident of North Carolina at the time of the original gift and the gift includes any of the following: (1) real or tangible personal property that is located in North Carolina and (2) intangible personal property that has a tax situs in North Carolina. The amount of tax is the maximum credit for state generation-skipping transfer taxes allowed under federal tax law. The tax return is due the same date as the federal return for payment of federal generation-skipping transfer tax. Under the EGTRRA, the federal generation-skipping transfer tax will be repealed in 2010 and is expected to be reinstated in 2011, as in the case of estate and gift taxes. The federal annual exclusion towards GST is currently at $2 million, as in the case of estate taxes. Tax Planning If you plan to transfer substantial amounts of property, either during your lifetime or at your death, you may need tax planning to minimize tax liability. Credits, deductions, and exclusions exempt a substantial amount of property from gift and estate taxes. Knowing how to use these credits, deductions, and exclusions may help you and your estate avoid taxes. You can reduce the value of your estate to the unified credit and avoid all estate taxes. However, reducing one s estate taxes to zero is often inconsistent with goals of good farm or business planning, and with maintaining final independence for the duration of one s life. Nonetheless, proper planning can reduce the value of your taxable gross estate and minimize your estate taxes in a manner consistent with your nontax goals. Gifts. You may give your property away before you die. If your gifts (of present interest) are valued at $12,000 or less per year per donee, you avoid gift tax. The property given away (with some exceptions, such as those discussed under the Gross Estate section) will not be counted in your estate. To the extent you reduce your estate s value to the amount of the unified credit or less, your estate will avoid owing estate tax. E x a m p l e 7 Each year you and your spouse give each of your four adult children $24,000 in gifts with no strings attached: $12,000 to each child from you and $12,000 to each child from your spouse ($96,000 in total gifts). If you and your spouse choose to split the gifts, the annual exclusion exempts the gifts from gift tax. Note that for split gifts, you and your spouse must file a gift tax return even though no tax is due. Each year you reduce the potential value of your estate, free of tax, by $96,000. Before giving away appreciated property, such as real estate or stocks and bonds, ask your attorney or accountant to explain the tax disadvantage to your donee in receiving the property as a gift rather than inheriting it. Many people are reluctant to give away their property for fear that they may need it. If giving away large sums of your property while you are alive is not acceptable, there are other ways to reduce the value of your taxable estate. Charitable donations. Donations to qualified organizations, such as charities, educational organizations, governmental agencies, and religious organizations, are free of gift and estate taxes. Charitable donations, during your lifetime and at your death, help reduce the value of your gross estate. Tax planning for married couples. Married couples have a distinct tax advantage. They not only have double the annual gift tax exclusion but double the unified credit. By effectively using both spouses unified credits, a married couple may transfer $4 million free of federal estate tax (for deaths that occur from January 2006 through December 2008). Failure to plan may result in an unnecessarily large tax bill upon the second spouse s death. Two simple examples illustrate the difference between planning and lack of planning. These examples are simplified to illustrate the importance of planning. They ignore all other credits and deductions that may be available to the estate. E x a m p l e 8 Father owns $3,800,000 worth of property. Mother owns $200,000 worth of property. Father and Mother have four children. Father dies in His will leaves his entire estate to Mother. His estate does not owe estate tax because property passing to the surviving spouse is free of estate tax. Mother now owns $4 million worth of property. Mother dies later in Her will leaves the property to her four children. The unified credit available in 2007 exempts $2 million from estate tax. The remaining $2 million is subject to estate tax. Her estate has a federal estate tax liability of $900,000 based on the EGTRRA in effect (Table 2) until 2010: Tax on the first $2 million $780,000 Plus tax on the next $2 million (45 percent) $900,000 Total net estate tax $1,680,800 Minus the unified credit on the first $2 million $780,800 Tentative tax amount $900,000 7

8 E x a m p l e 9 Father owns $3,800,000 worth of property. Mother owns $200,000 worth of property. Father and Mother have four children. Father dies in His will leaves $1,800,000 to Mother outright. The remaining $2 million is placed in a credit shelter or a bypass testamentary trust to benefit Mother during her lifetime, with the children as residual beneficiaries. A bypass or credit shelter trust is a common form of trust used by married couples to eliminate or reduce estate taxes in cases where the value of their estate exceeds the amount exempted under estate tax laws. The $1,800,000 left to Mother is free of estate tax because of the marital deduction. The $2 million placed in trust is free of estate tax because of Father s unified credit. Father s estate does not owe any estate tax. Mother now owns $2 million worth of property and has the benefit of another $2 million left in trust. Mother dies in Her will leaves her property to her children. The $2 million placed in trust by Father is not included in her gross estate and, on her death, is transferred to her children. Mother s estate (valued at $2 million) does not owe estate tax because of Mother s unified credit. Together, Mother and Father have transferred $4 million to their children free of estate tax. In Example 8, the children s inheritance was reduced by $900,000 in estate taxes. In Example 9, the children s inheritance remained intact without being reduced by estate taxes. The difference was in planning. Example 9 describes only one possible planning strategy. Other plans may produce similar tax results. The examples also assume that Mother survived Father. Married couples also want to plan for the possibility that the husband may survive the wife. The goals are to use both spouses unified credits and to reduce the size of the taxable estate owned by the second spouse when he or she dies. Planning tips. Pay careful attention to how you own your property. Assets owned jointly with a right of survivorship may frustrate planning goals. Consider dividing property to equalize the estates. Also, do not overlook contractual assets, such as life insurance or retirement plan benefits, which may increase the your estate s value. Tax planning requires professional help to ensure the proper tax results. Consult your attorney or accountant for more information. Summary Tax planning can be complex and vary with the size and potential tax liability of estates. Be sure to research and understand the tax implications of gift giving and estate planning before you proceed. Careful planning and use of professional assistance can minimize potential estate tax burdens for North Carolina families. Other Resources Federal unified credit and estate tax exemptions Inheritance tax repeals and state tax credits Tax_Bill.pdf North Carolina generation-skipping transfer taxes By Section/Chapter_105/GS_ html North Carolina gift taxes By Article/Chapter_105/Article_6.html html Prepared by Theodore A. Feitshans, J.D., and Guido van der Hoeven, Ph.D., Extension Specialists, Department of Agricultural and Resource Economics, College of Agriculture and Life Sciences Mark Megalos, Ph.D., Extension Forestry Specialist, College of Natural Resources Sreedevi Gummuluri, Ph.D. Candidate in Economics, N.C. State University Previous versions of this publication were prepared by Carol A. Schwab, Adjunct Professor, N.C. State University; Nathan M. Garren, former Extension Economist, N.C. State University; and Barrie Balzli Stokes, former Family Resource Management Specialist, N.C. State University. The current authors are solely responsible for any errors or omissions. This publication is provided as a public service and is designed to acquaint you with certain legal issues and concerns. It is not designed as a substitute for legal or other professional advice, nor does it tell you everything that you may need to know about this subject. Future changes in the law cannot be predicted, and statements in this publication are based solely upon the laws of North Carolina and the federal government in force as of September No legal advice is provided nor is any professional relationship formed by provision of this publication. If you do not have an attorney, you may obtain the name of an attorney in your area through the North Carolina Lawyer Referral Service (NCLRS), a public service of the North Carolina Bar Association. To reach a NCLRS counselor, call or in the Wake County area. 10,000 copies of this public document were printed at a cost of $1,654 or $0.16 per copy. NC STATE UNIVERSITY Published by NORTH CAROLINA COOPERATIVE EXTENSION SERVICE AG E /08 10M BS/KEL

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