In 2015, a very important ruling was handed down by the United States Supreme Court that mandated the federal recognition of same-sex marriages. It impacted estate planning for affluent gay and lesbian couples, and a New York resident had a lot to do with it.
This woman, Edith Windsor, was forced to pay the federal estate tax when she received a large inheritance from her spouse, who was also a woman. She did not think this was fair, and she filed a lawsuit.
Why would this be something that would wind up in court? Read on to find out the answer to this question.
Federal Estate Tax
The estate tax was established in 1916, and it has been in place ever since (with the exception of a one-year repeal in 2010).
This tax has always targeted high net worth individuals. To draw a line between people who are exempt and those who must pay the tax, there is a federal estate tax credit or exclusion. This is the amount that you can transfer free of taxation.
A $5 million exclusion was put into place for 2011. Since then, this base has been retained, but there have been ongoing adjustments to account for inflation. During 2016, the amount of the exclusion is $5.45 million, but it could be increased a bit next year if another inflation adjustment is added.
The top rate of the federal estate tax is 40 percent, and this represents a rather hefty portion of your financial legacy if you are exposed.
Transfers Between Spouses
The federal estate tax is potentially applicable when assets are being transferred to anyone other than your spouse. There is an unlimited marital estate tax deduction. You could utilize this deduction to transfer any amount of money and/or property to your spouse free of taxation.
Prior to the aforementioned Supreme Court ruling, this deduction was not allotted to married gay couples, even if they were legally married in some jurisdiction. This is because of provisions contained within the Defense of Marriage Act that defined marriage as a union that can only be entered into by a man and a woman.
Now that same-sex marriages are legal in the eyes of the federal government, the marital deduction is available to any legally married couple.
There is one asterisk of sorts that we must add to our explanation of the marital deduction. To utilize the unlimited marital estate tax deduction, the surviving spouse must be a citizen of the United States.
If you are a United States citizen and you are married to a citizen of another country, you cannot bequeath assets to your spouse free of the federal estate tax.
There is a logical rationale behind this stipulation. If you are in possession of a taxable estate and you leave it to your citizen spouse tax-free, the estate tax is still looming.
Your surviving spouse would be faced with estate tax exposure on the same assets that you passed along. You did not avoid the estate tax by leaving a tax-free bequest to your spouse; you simply delayed its imposition.
This is why estate planning is still necessary, even if you are married. Utilization of the unlimited marital deduction is not a comprehensive tax efficiency solution.
On the other hand, imagine the scenario that would exist if the unlimited marital deduction could be used by a non-citizen spouse. The government may never see any money, because the surviving spouse could return to his or her country of citizenship with a tax-free inheritance in hand. The American IRS could never collect anything after the death of the surviving spouse.
Federal Gift Tax
You would logically consider lifetime gift giving when you hear about the federal estate tax. However, this window has been closed by the existence of the federal gift tax.
The gift tax is unified with the estate tax, so the $5.45 million exclusion is a unified exclusion. It applies to lifetime gift giving along with postmortem asset transfers.
Any portion of the unified exclusion that you use giving gifts during your life would be deducted from the exclusion that could be applied to your estate after your passing.
The unlimited marital deduction also extends to lifetime gift giving.
State-Level Estate Tax
In New York, there is a state-level estate tax. The marital deduction applies on the state level also, regardless of gender of the people involved.
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If you would like to obtain more information about estate planning, attend one of our seminars. These sessions are offered free of charge, and you can visit our seminar schedule page to get all the details.