Estate and Gift Taxes

Nothing is certain but death and taxes. And some taxes are due even after you die.

Your estate is the total value of all your investments and retirement accounts, your home, and any other assets, minus your debts and the cost of settling your estate. If the value of your estate is less than $2 million in 2006, 2007, and 2008, it will escape federal estate tax if you die during those years. That amount is scheduled to increase to $3.5 million in 2009. Estate taxes are scheduled to be eliminated entirely in 2010.

But unless Congress makes the changes permanent, the tax-exempt amount will go back to $1 million in 2011 and the tax rate will be reinstated at 2001 levels of 55%. However, it's also possible that the exempt amounts will increase faster or that estate taxes will be eliminated sooner.

Calculating your net worth

It pays to compute your approximate net worth while you're still alive. You may be surprised to find that the value of your possessions, minus mortgages and other debts, has climbed above the taxable amount.

Be sure to include the amount you have built up in retirement plans, and an accurate assessment of the market value of your home and your equity in it. Other assets to consider are the face value of your life insurance policies, which could put you over the taxable threshold, and any inheritance you anticipate.

If your estate is over the taxable amount or seems likely to top that number, you need an expert tax adviser and a lawyer who specializes in wills and estates. It pays to review your will and estate plan periodically, especially if the value of your assets, the make-up of your family, your wishes for sharing your assets, or the tax laws change.

The value of your property, such as your home, stocks, and bonds is figured at the fair market value on the date of your death or six months after – not at what you paid for the property. Your executor picks the valuation date. Using the current market value may raise the value of your estate, but it also means that, in most cases, neither your estate nor your heirs will pay capital gains tax on any increased value of the property that occurred before your death.

Under current law, property you leave to beneficiaries in your will passes to them at current market value, or what's known as a step up in basis. However, that provision is scheduled to change if estate taxes are permanently eliminated.

Planning basics

  • Planners try to arrange married couples' estates so that both spouses can take advantage of the estate tax exemption. The first to die may leave assets directly to children or heirs other than the spouse. Or the assets may be put in a trust, with the income going to the spouse until she or he dies. Then the balance goes to the other heirs tax free.
  • Life-insurance proceeds aren't subject to income tax. But they are included in your taxable estate if you own the policy on your life when you die or if you assigned ownership to someone else during the three years before your death. However, you can create a life insurance trust to own the policy on your life. When you die, the trust collects the proceeds, and they aren't included in your estate.
  • If you expect your estate to be taxed, you should arrange for it to raise cash to pay the taxes. You also want your estate to have cash to pay for your funeral, to pay off your debts, and to cover your estate's administration expenses. The estate can deduct these expenses to reduce its value.
  • Consider charitable bequests to reduce your taxable estate. Before death, you can use trusts to give property to a charity while taking a charitable deduction and retaining income for yourself.

Gift taxes

You can avoid estate and gift taxes on annual gifts of up to $13,000 each to as many people as you like. So can your spouse. For example, a couple with three children may give each child $26,000 a year and reduce a potentially taxable estate by $78,000 annually.

In addition to the $13,000 you can give to individuals, you can pay unlimited medical expenses or tuition for anyone – a grandchild, perhaps – without being subject to gift tax. You also can deduct the medical expenses you pay on your tax return to the extent they exceed 7.5% of your adjusted gross income (AGI) as long as the patient is a dependent. But you must pay the hospital, doctor, or college directly. You can't give the money to the patient or the student without incurring potential gift taxes.

You can make taxable gifts during your lifetime, and no tax is actually due until the accumulated value of the gifts reaches $1 million. Then you owe tax at the same rate that applies to taxable estates. In 2006 the top rate is 46%.

The marital deduction

While you're alive, you may make unlimited tax-free gifts to your spouse. When you die, you can leave your entire estate to your spouse free of estate tax – provided, in both cases, that he or she is a U.S. citizen. Your spouse's estate will be taxed at his or her death at whatever rate applies at that time.

If your spouse is not a U.S. citizen, your tax-free gifts are limited to $120,000 a year. You probably should consider establishing a qualified domestic trust to soften the tax blow and make it easier to share assets. If you're not married, you'll want to work with an experienced financial adviser to find the most tax efficient solutions for gifting assets or leaving an estate.

If a wife and husband own property, such as a home, as joint tenants with the right of survivorship, only half the value is included in the estate of the first to die. If joint tenants aren't married to each other, the whole property is usually included in the estate of the first to die. The estate's representatives can reduce the potential estate tax by proving that the survivor paid for all or part of the property, or received a share of it by gift or inheritance.

IRA donations

Some wealthy individuals arrange to have their IRAs donated to qualified charitable organizations when they die. That way, their estates escape paying estate and income taxes on the value of that asset.

Any tax or legal information in this website is merely a summary of our understanding and interpretations of some of the current income tax regulations and is not exhaustive. Investors should consult their tax advisor or legal counsel for advice and information concerning their particular situation. Wells Fargo Funds Management, LLC, Wells Fargo Funds Distributor, LLC, nor any of their representatives may give legal or tax advice.

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