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Understanding Federal Estate Tax

The Federal Estate Tax changed significantly in early 2013, and many Americans are still catching up with the changes. Here is a laymen's guide to the federal estate tax and how it affects most Americans:

It doesn't affect most Americans--at all.

Permanent. Starting in 2013, and remaining permanent thereafter (or until congress changes the estate tax laws again), the federal estate tax exemption level is $5 million per person. This is the amount a person can die owning without paying any federal estate tax.

Indexing. Furthermore, this amount is indexed for inflation. In 2014, it is $5.34 million per person.

Portability. In the past, higher net worth couples had to hold assets in one spouse's name or the other, so that each spouse could take advantage of his or her individual exemption amount (jointly owned assets simply passed to the surviving spouse, and were subject to an unlimited spousal exemption from the federal estate tax).Once a spouse died with any unused exemption amount, the exemption was lost. This required wealthier couples to draft Wills with coordinating trust clauses, such as "credit shelter" trusts and "A-B" trusts.

Now, each spouse's exemption is portable upon death, which means that any unused spousal exemption amount may be transferred to the surviving spouse. However, a federal estate tax return must be filed to transfer this exemption between spouses. This has prevented the need for asset-balancing between spouses, and complex trust coordination within Wills, at least solely for federal estate tax purposes.

Unified. As discussed in other posts, the federal estate tax exemption is "unified" with the federal gift tax exemption. In other words, a gift that reduces a person's gift tax exemption will also reduce the amount that the person can die owning without paying federal estate tax.

From 2001 to 2013, we were faced with constant sunsetting provisions for the federal estate tax, which had the effect of creating uncertainty regarding the estate tax. While no law is permanent, the above characteristics have improved the ability for most families to effectively plan for the future.

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