2014 Tax Update
The American Taxpayer Relief Act, which was signed by President Obama on January 2, 2013, implemented those federal estate and gift tax laws that shall control during 2014. Under this law, the federal estate and gift tax exemption was indexed for inflation, and therefore increased from $5.25 million per person in 2013 to $5.34 million per person in 2014. In other words, each individual can transfer up to $5.34 million tax free, during life or at death, but transfers over this amount will be taxed (the maximum tax rate is 40%). Likewise, the generation-skipping transfer (GST) tax exemption was reunified with the federal estate tax exemption, meaning it will continue to match the federal estate tax exemption, subject to the same annual inflation index.
There is still an unlimited marital deduction from the federal estate and gift tax that operates to defer estate tax on assets inherited from a spouse until the second spouse dies. This marital deduction only applies if the inheriting spouse is a U.S. citizen.
The Act had also made permanent the concept of “portability,” which is a tax break offered to married couples. A surviving spouse can add a recently deceased spouse’s unused exemption to their own unused exemption. This enables a surviving spouse to transfer up to $10,680,000 federal estate tax free for 2014. While the unused exemption might be portable, the amount sheltered does not adjust for inflation.
Keep in mind that portability is not automatic. The fiduciary of the estate of the spouse who died must transfer the unused exemption to the surviving spouse by timely filing a federal estate tax return. Furthermore, portability may not be an attractive option to some couples since there is no portability for unused Illinois exemption.
On a state level, the Illinois estate tax exemption is fixed and consequently not indexed for inflation. As such, it will continue to be $4 million for 2014, with a maximum tax rate of 16%. Portability is not available for the Illinois estate tax exemption.
There continues to be a disconnect between the federal and Illinois estate tax exemptions. Some estate plans call for a division of assets between a credit shelter trust (sometimes called the “Family Trust”) and a marital trust according to a formula that allocates the maximum amount that can be sheltered from the federal estate tax to the credit shelter trust. Of course, with the substantially increased federal exemption, a greater portion (or perhaps all) will be allocated to the credit shelter trust.
With the Illinois estate tax exemption set at $4 million, an Illinois decedent with a $5.34 million estate that is administered under a typical formula clause (allocating the $5.34 million to the credit shelter trust) would expose that trust to Illinois estate tax. The Illinois legislature created a “patch” – the so-called “Illinois QTIP election” to defer the Illinois tax until the death of the surviving spouse, but the trust must be drafted to qualify for that election. If you have not reviewed your current estate plan, we recommend that you consider doing so to make sure your plan document is eligible for the Illinois QTIP election.
One simple way you can reduce estate taxes and, in limited circumstances, shelter assets to achieve Medicaid eligibility, is to give some or all of your estate to your children (or anyone else) during their lives in the form of gifts. Certain rules apply, however. There is no actual limit on how much money you can give during your lifetime, but if you give any individual more than $14,000 in 2014, you must file a gift tax return reporting the gift to the IRS and use your available exemption to offset the gift tax due.
The $14,000 figure is an annual exclusion from the gift tax reporting requirement. You may give $14,000 to each of your children, their spouses, and your grandchildren (or to anyone else choose) each year without triggering any IRS reporting requirements. In addition, if you’re married, your spouse can duplicate these gifts. For example, a married couple with four children could gift up to $112,000 in 2014 to their children with no gift tax implications. In addition, the gifts would not count as taxable income to their children (although any earnings on the gifts would be taxed.)
Keep in mind that payments directly to an institution for tuition or to a provider for medical expenses on someone else’s behalf are not treated as taxable gifts and do not count against the $14,000 annual exclusion.
There is still no news on whether Congress will extend the tax break on IRA rollovers to charities. Until February 1, 2014, there is a $100,000 “charitable rollover” of IRA distributions for anyone older than 70 ½. Consequently, a taxpayer can direct up to $100,000 from an IRA to a charity and not have the amount included in his gross income. These rollovers, known as qualified charitable distributions, were in effect for 2013 with special rules being applied:
- An individual who received an IRA distribution during the month of December 2013 may transfer a portion not exceeding $100,000 in cash to a qualified charity before February 1, 2014, and the distribution will be excluded from 2013 income.
- Alternatively, during January 2014, an individual may request that up to $100,000 be transferred directly from his or her IRA to a qualified charity before February 1, 2014, and have that amount included from 2014 income.