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Changes to the Estate and Gift Tax

June 17, 2011

By Dianne L. Rizzo, EA

In an effort to reduce the state deficit, the governor signed the state budget which included changes to the estate and gift tax retroactive from January 1, 2011. 

The new law drastically reduced the estate and gift tax exemption from $3.5 million to $2 million.  The new exemption amount is applicable to all decedents dying on or after January 1, 2011.  The new gift tax exemption applies to all Connecticut taxable gifts made since the gift tax was enacted on January 1, 2005.  The tax rates on transfers over the exemption, whether by gift or inheritance, begin at 7.2% and increase to a maximum of 12% on transfers over $10.1 million.

Estate tax returns are still required for all estates, including non-residents with Connecticut real or tangible property.  If the estate is over the $2 million exemption the return is filed with the Connecticut Department of Revenue Services as well as the local probate court.  Smaller estates continue to file only with the probate court.

The Federal tax law has a maximum lifetime exemption for estate and gift tax purpose.  Under the 2010 Tax Act this amount is $5 million, which will expire on December 31, 2012.  At that time the rates will revert to the 2001 level, currently indexed at approximately $1.4 of exemption and 55% maximum tax rate.

The disparity between the Federal and the Connecticut exemption amounts for estate and gifts taxes creates challenges to estate planning.  A plan that was designed to pass everything tax free on the death of the first spouse may now be subject to significant tax on the state side.

For example, a married couple has an estate plan that passes the federal exemption amount ($5 million) to a “credit-shelter” or “by-pass” trust for the benefit of the surviving spouse with the remainder passing tax free to a “marital” trust or outright to the spouse.  Currently this would create no tax at the federal level; however, the Connecticut tax liability would be $229,800.

The solution to this would be to ensure the estate plan was designed to pass the amount that passed free of federal and Connecticut tax.  A lesser amount is passed to the “credit shelter” or “by-pass” trust creating no tax liability at the death of the first spouse.

However, couples with a large estate may prefer to pay some tax at the death of the first spouse to minimize the estate tax liability on the second death.  The additional $3 million being deferred to the second estate may carry a tax liability at a higher tax rate for both federal and state purposes.  The assets, however, will continue to grow without the fear of further estate taxation.

Couples with a modest estate have different needs.  The surviving spouse may be more concerned with the availability of assets for their current support than the future tax liability.  The idea of paying a large Connecticut estate tax bill currently would not be viewed as an advantage.

Another commonplace situation in which planning would be essential is with blended families.   A typical estate plan for a second marriage is to pass the exemption amount to the children of the first marriage, the remaining amount to a marital trust for the current spouse.  If the estate plan was drafted prior to 2005 when the federal and Connecticut exemptions were not decoupled, the documents may only refer to the federal exemption amount.  The resulting marital trust would be significantly lower with the added burden of the Connecticut tax liability. 

The 2010 Tax Act also created portability of federal estate tax.  If a decedent does not have enough assets to take advantage of the $5 million exemption amount, the unused portion will pass to the surviving spouse.  Although there are advantages with portability, there are shortcomings as well.  Under the current law, portability is scheduled to disappear on December 31, 2012 with the $5 million exemption.  Connecticut does not have portability with respect to the exemption amount.

It is important to review estate planning documents to take advantage of tax-saving opportunities.  In most family situations taxes are an important consideration in transferring wealth.


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