The federal estate tax was in a state of flux from 2001 until 2013. We saw the “coupon” amount (the amount that can be transferred without estate or gift tax liability) go from $1 million to $5 million, and in 2010, the estate tax took a 1-year vacation. The estates of people who died that year could pass entirely free of estate tax. Things seem to have stabilized, with Congress setting the coupon amount at $5 million. What is more, the coupon is adjusted for inflation, so the total exemption is $5.25 million in 2013 and $5.34 million in 2014.
Here is a simplified explanation of the way the federal estate and gift taxes work: when a person dies, the value of everything he or she owned is determined, and, if that value exceeds the coupon amount, the excess value is taxed at 40%. The estate tax is due, in cash, 9 months after the person died. If a person gives property away during life, then the first $14,000 of value given to each of an unlimited number of recipients is ignored, and the person’s coupon is applied against any excess value given away. In other words, if a mother gives her daughter $25,000 worth of assets, the first $14,000 is ignored by virtue of the annual gift tax exclusion, and the $9,000 excess is sheltered by the mother’s coupon amount. The following year, the mother can give her daughter another $14,000 with no transfer tax consequences, and again, the mother’s coupon can be applied against any excess value given to the daughter. This process can continue for the remainder of mom’s lifetime, and when mom eventually dies, whatever is left of her coupon can be applied against the assets she owned at death. If there is not enough remaining coupon to cover the remaining assets, the 40% estate tax will gobble up a portion of the excess value. If mom used up her coupon during her lifetime but still owned some assets at death, the estate tax will consume 40% of her estate. If mom used up her coupon during life and continued giving assets away, she could continue to shelter the first $14,000 given away per recipient per year, but any excess gifts would be subject to a 40% gift tax.
There is yet another transfer tax imposed by the Internal Revenue Code. It is the “generation-skipping transfer tax” (GSTT), which imposes a 40% tax on top of any gift or estate taxes payable if the transferor gave something to someone who was 2 or more generations younger than the transferor. As a general rule, the annual exclusion and the coupon amount can be used to shelter generation-skipping transfers from GSTT.
Not content to sit on the sidelines while Congress has all the fun, the Hawaii State Legislature enacted an estate tax and GSTT in 2010. Essentially, the Hawaii tax adds another 10% on top of any federal transfer tax payable. Hawaii currently has no gift tax and it has a coupon that matches the federal coupon. However, there is a move afoot to establish a Hawaii gift tax and to set the Hawaii coupon amount at a lower value than the federal coupon. If this happens, a surviving spouse of someone who died with an outdated estate plan may end up with unexpected (but avoidable) tax liability. The kind of language that has worked for literally decades to postpone all estate tax until both spouses are gone, will no longer work. It is uncertain whether Hawaii will take this step, but don’t count on the State easily passing up a potential revenue source.