From Letters to My Clients: Estate Taxes 101
Updated: Apr 15, 2018
You have asked what taxes would be owed, should you die tomorrow with your current estate plan in place. Based upon my review of your documents, under the current Connecticut state estate tax exemption of $2.6 million per person, your estate, with assets valuing nearly five million dollars, would be exposed to tax liability. This can be remedied fairly easily, but requires some explanation.
Every taxpayer is allotted a unified lifetime exemption from estate and gift (transfer) taxes. The federal exemption is currently $10.98 million per person. The Connecticut lifetime exemption is much smaller – $2.6 million per person. Accordingly, state taxes will be owed on the estate of a Connecticut resident if the estate contains more than $2.6 million worth of assets.
Fortunately, there are two deductions that are unlimited when it comes to estate taxes. One is the marital deduction and the other is the charitable deduction. This means that you can leave as much as you want to your spouse or to a qualified charity, and no estate taxes will be owed. If Bill Gates were to die leaving everything (let’s say ten million dollars) to his wife Melinda, the estate will owe no taxes because the marital deduction is unlimited.
Does that mean that the unlimited marital deduction makes the lifetime exemption irrelevant? On the contrary, the lifetime exemption should be preserved in order to shelter as much property from estate taxes as possible. Relying only on the unlimited marital deduction effectively “wastes” the lifetime exemption of the first spouse to die. In other words, if Bill Gates were to leave everything to Melinda, although the unlimited marital deduction would mean no estate taxes would be owed, he would lose out on his lifetime exemption – the unique opportunity to shelter (in Connecticut) $2.6 million worth of assets from taxes.
This is because what you leave to your spouse is considered by the taxing authorities to be marital property to which the marital deduction is applied. (Under federal law, if a married decedent whose estate is taxable failed to preserve his lifetime exemption during his life, it could be preserved shortly after his death by way of a mechanism called “portability.” Under Connecticut law, however, there is no portability.)
To illustrate, assume Melinda Gates dies a widow a few years after Bill, owning exactly $2.6 million worth of her own assets. Assume also that she spent none of the ten million in assets left to her by her husband. Recall that Bill’s ten million was considered deductible via the unlimited marital deduction. Bill did not preserve his lifetime exemption of $2.6 million by giving it to his children or transferring it to a trust, transferring $7.4 to Melinda instead of $10 million.
As a result, upon Melinda’s death, estate taxes will be owed on ten million dollars, or everything except for her personal exemption of $2.6 million. If Bill had done some estate planning, $5.2 million total could have been sheltered from estate tax instead of only $2.6 million. For this reason, estate planning attorneys often describe the unlimited marital deduction as more of a deferral than a deduction. Estate taxes will be owed on the death of the surviving spouse.
In order to ensure the preservation of the lifetime exemption and shelter as much property as possible from estate taxes, married couples often set up revocable trusts that allow the lifetime exemption and the unlimited marital deduction to work together.