When a large amount of wealth is being transferred, it is essential to understand what taxes can occur. This blog will cover the importance of understanding the federal estate tax, the power of the marital deduction, and South Dakota's Special Spousal Trust.
Understanding Estate Tax
Unified Credit is a term used in estate planning. It couples the estate tax with the gift tax, and applies to both the gift and estate taxes. The estate taxes are calculated from the gross estate. There are a few deductions made from the gross estate that can reduce the amount subject to taxes. The two most essential deductions are the marital deduction and the charitable deduction. These are subtracted from the gross estate, determining the overall taxable estate. Property owned at death, given to a spouse or a charity, is not subject to estate taxes. Beyond that, any of the basic exclusion amounts that remain up to the $11.58 million is tax-free. Any amount that is over the basic exclusion amount is taxed at 40% and paid by the estate.
Married couples have many tax advantages and can utilize portability to exclude the maximum amount as possible. Portability gives flexibility to a spouse so that if they do not use their entire exclusion amount, they can transfer it to their spouse. The surviving spouse can use their full-time exclusion plus the unused portion of the exclusion of the other.
The marital deduction has been a useful way to shelter spouses from being subject to high estate taxes. The reason behind its creation in the 1980's is, transfers from one spouse to another spouse should not be subject to tax. Section 2056 of the internal revenue code grants unlimited transfers between spouses as tax-free if there is no "terminable interest." However, for a marital deduction to qualify, it must follow these requirements:
· The decedent, person who has died, must be a citizen or resident of the U.S.
· The passing requirement, which means the interest must pass to the surviving spouse from the decedent spouse.
· The property must pass to the surviving spouse.
· The recipient must be the spouse of the decedent.
· The property must be included in the decedent's gross estate.
The Special Spousal Trust
The Special Spousal Trust is a common trust used for its tax advantages for married couples. South Dakota is a separate property state, so each spouse is considered to own half of the shared property titled in both spouses' names. As a result, at the death of one of the spouses, the other spouse receives a 50% step-up in basis of the property for federal tax purposes. Some states have community property laws. These laws consider both spouses to have 100% interest that is undivided with the community property. This means, if one spouse dies, then they receive a 100% percent step in basis.
Special Spousal trusts must receive consent and be executed by both parties. This trust allows a married couple's property in South Dakota to be treated as community property regardless of the amount each has contributed. Widows and widowers residing in separate property states are subject to a special provision of the federal tax code that allows a 50% step-up in basis at the death of a joint tenant. Taking advantage of a special spousal trust can be very advantageous. The disadvantage of not living in a community property state is a couple could be subject to a capital gain tax on the sale of their property after one spouse dies.
The Special Spousal Trust is especially helpful in situations where there are highly appreciated assets. The Special Spousal Trust allows spouses to avoid paying capital gains if assets are sold after one of the spouses' death. The Special Spousal Trust is especially helpful in situations where there are highly appreciated assets.
Here is an example:
Tony and Paula have 1000 acres in South Dakota and are joint tenants. Tony dies, and Paula sells the land. The original cost basis was $50/acre, and at Tony's death the land is worth $1000/acre. If the couple did not set-up a Special Spousal Trust, then Paula would receive a step-up in basis for half of the property. When Paula sells the land, she will have to pay tax on the capital gains. In the Special Spousal Trust, the land is community property Paula will not owe capital gains.
There are many different techniques and ways to shelter an estate from paying high estate taxes, so careful estate planning is crucial. Understanding a few essential items like the marital deduction and the Special Spousal Trust, can save beneficiaries and spouses a lot of money. It is necessary to carefully plan with your estate attorney to explore your options. If you want to learn more about the benefits of South Dakota, click the link below.