FEDERAL SYSTEM

The federal estate tax exemption amount is $11,180,000, per person, for persons who die in 2018. This is a dramatic increase from previous years. The top federal estate tax rate is 40%, which is levied on the amount in excess of the exemption amount.

A decedent’s estate receives a deduction for all property left to the surviving spouse. Thus, no matter what one’s net worth might be, if all property is left outright to the surviving spouse there would be no estate tax upon the first spouse’s death. The problem is that the property left to the spouse would then be taxed upon his or her death to the extent the net worth of the second estate exceeded the exclusion level, subject to the new portability rules.

The estate tax limitation goal of any proper plan is to take advantage of the marital deduction coupled with the exclusion amount in order to avoid estate taxes at the first death, and limit or avoid estate taxes at the second death. The tricky thing is that now the Washington State exclusionary level is less than the federal level.

Federal rules now allow a surviving spouse’s estate to not only exclude their own annual exemption amount ($11.18 million in 2018), but to increase the exclusion by any amount unused in the estate of the first to die. In other words, if a couple is worth twenty million dollars and their wills leave everything to each other followed by distribution to their children, there should be no federal estate tax at either death. At the time of the first death the devise to the surviving spouse receives the marital deduction; at the time of the second death the estate is entitled to the annual exemption ($11.18 million in 2018), plus the $11.18 million that would have been available in the first estate were it not for the marital deduction.
A person can annually gift a certain amount ($15,000 in 2018) to an infinite number of donees free of federal gift tax. A married couple can gift $30,000 in 2018 to an infinite number of donees gift-tax free. To the extent gifts exceed the annual exclusion, gift tax is not owed, but the excess gift reduces one’s basic exclusion amount. The amount of the excess gift(s) is subtracted from the basic exclusion ($11.18 million in 2018).
In order to determine whether federal estate or state inheritance taxes are owed one’s estate is appraised. This process establishes a stepped-up basis to date-of-death value which can be a tremendous tax advantage for the heirs. For example, if a person buys a share of stock for $50 and it increases in value to $100, should he sell it he would have to pay capital gain tax on the $50 increase. However, upon his death, his heirs receive a stepped-up basis to date-of-death value – up to the $100 value. They can then sell it with no gain. The same applies to real estate. Thus, as one gets older, one must consider whether he/she should sell appreciated property and face capital gains tax, or let his/her heirs inherit the appreciated property, obtain a stepped-up basis and then be able to sell the asset tax free.

WASHINGTON STATE

Many U.S. states also impose their own estate or inheritance taxes. Some states, such as Idaho, “piggyback” on the federal estate tax law in regard to estates subject to tax (i.e., if the estate is exempt from federal taxation it is also exempt from Idaho State inheritance tax). Washington no longer adopts the federal system. It limits the basic exclusion to two million dollars for deaths occurring between 2006 and 2013, with the amount indexed with inflation beginning in 2014. (As of 2018, the exclusion amount is $2,193,000.) Real estate owned by a Washington decedent, located outside the State of Washington, is not included as part of their taxable estate concerning the Washington $2 million exclusion limit.
Like the federal system, a Washington decedent is entitled to an unlimited marital deduction. Thus, with proper planning a married couple should be able to pass a net estate worth $4 million (more for deaths occurring after 2013) free from estate inheritance tax.
Washington did not adopt the portability rules which the federal government recently enacted. Thus, if a married couple is worth four million dollars and the husband dies and leaves his one-half of the community property to his wife, there is no inheritance tax at that time because: 1) his net worth did not exceed two million dollars; and 2) he is entitled to a marital deduction. However, the wife is now worth four million dollars and at her death inheritance taxes will be imposed to the extent her estate exceeds two million dollars.

Washington does not impose a gift tax. Therefore, lifetime gifts of Washington property escape Washington estate tax, i.e., lifetime gifts do not consume part of the Washington exemption amount.

So a Washington resident worth $3 million could, the day before his death gift a million dollars resulting in his estate being valued below the $2 million exclusion amount, with a result of no death tax liability.

$2.5 million in a family-owned business can be excluded from a decedent’s Washington estate. One must meet a number of criteria including that the value of the family-owned business must exceed 50% of the decedent’s gross estate. There are material participation requirements – the decedent must have been actively involved in the business for several years before death and a family member must be actively involved in the business for several years after death.

The value of the decedent’s family-owned business interest cannot exceed $6 million.

There is a family-owned farm exclusion which is unlimited in value. Essentially, if the criteria are met and if the farm is kept in the family, its value can be excluded from one’s taxable estate under both state and federal rules.

To ensure that a married couple can pass up to $4 million tax free to their children, their estate plan should include wills that utilize either a credit shelter trust or a disclaimer trust.

A credit shelter trust works as follows. The will of the first to die mandates that a portion of his estate, usually the $2 million exclusion amount, is placed in trust. The surviving spouse receives the income from the trust. Upon his/her death, the trust is divided equally among the couple’s children. The amount placed in trust is less than the $2 million exclusion and is not included in the value of the estate of the second to die. Because the trust is mandatory, it protects the amount of the trust from the surviving spouse’s ability to consume, remarry and lose the inheritance, etc.

Under a disclaimer trust, the first to die leaves his/her entire estate to his/her surviving spouse. At the time of the first death, the surviving spouse determines what his/her net worth will be. To the extent it exceeds $2 million, he/she considers disclaiming a portion of the inheritance to keep his/her net worth below $2 million. The amount disclaimed is placed in trust, the surviving spouse receives the income from the trust and manages the trust, and upon his/her death the trust is divided equally among their children.