The topic of Estate tax has been a major area of concern in the recent past. It has sparked a lot of arguments across the United States. With the ratification of the ‘American Tax Relief Act of 2012’, the laws relating to Estate tax have been made simpler. The estate tax is levied on handover of the ‘taxable estate’ of a deceased person irrespective of the method of transfer. The tax is applied to every citizen and resident of the United States of America. This paper seeks to discuss various aspects of the estate tax. Specifically, it seeks to advise a couple on how to protect their estate from taxes in the event of death.
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Tax minimization related to estate taxes
The estate tax is administered by the requirements of the Internal Revenue Services (IRS). Under the current requirements of the IRS, the estate tax is taxable at a maximum tax rate of 35%. Further, it is exempted up to $5.12 million. The first step of computing the estate tax is estimating the amount of the gross estate. Further, in the provision of the IRS, the gross estate is computed using the fair market value of all the estate of the family. Further, several deductions can be subtracted from gross tax before arriving at the taxable estate. Some of the deductions are funeral expenses, mortgage payable contributions to charity and selected items of property left to the surviving spouse (Internal Revenue Services, 2013). The fair market value of the estate is adjusted with the amount of related allowable deductions to obtain the value of the net value of the Estate.
The exemptions provided in the laws are deducted from the amount of the net value of the estate. Thereafter, the tax rate is applied to the resulting amount. Planning for Estate tax before death is significant since it ensures that the process of transferring the Estate to the descendants is successful. Besides, the process ensures that the couple reduces the amount of Estate tax that will be deducted from the value of their estate. As mentioned in the case study, the family owns a farm and several business houses (Internal Revenue Services, 2013). They need advice on how to protect their wealth from Estate tax upon death. Based on the provision of the IRS, Estate tax is unavoidable just like the gift tax. However, there several legal methods that an individual can use to reduce the amount of the Estate tax. The methods will allow the couple to transfer their wealth to the three children in a tax-effective method. Therefore, the couple needs to use tax-efficient ways to plan for their estate tax (Anderson, Pope & Kramer, 2013).
Most viable legislative proposals related to estate tax
As mentioned in the section above, under the current requirements of the IRS, the Estate tax is taxable at a maximum tax rate of 35%. Further, it is exempted up to $5.12 million. As outlined in the guidelines of the IRS, these provisions were applied until the end of the previous year. From the beginning of this year, the provisions provided by the IRS were changed. The Estate tax is taxable at a higher maximum tax rate of 55% up from 35%. Further, it is exempted from a lower value of $1 million down from $5.12 million. However, the president of the US proposed more lenient changes to the Estate Tax. He suggested that the tax rate be lowered to 45% up from 55% while the exemption amount should be increased to $3.5 million down from $1 million.
Apart from the US president’s proposal, the Congress also proposed some changes to the Estate tax. The Congress was divided into three groups. The first group comprised of Extenders. The group comprised of people who originated from the farming states. The group suggested that the previous provisions provided by IRS be applied, these are, a maximum tax rate of 35% and an exemption amount of $5.12 million. The second group comprised of Conformers. They followed the president’s suggestion. The final group was ‘reverters’. They suggested a tax rate of 55% and an exemption amount of 55%. Based on these several proposals, several actions can be taken. The first is not to take action. The second action is coming up with a new proposal. The third action is sanctioning a concession bill. The fourth action is extending TRUIRJCA and the final action is annulling the Estate tax. The most feasible suggestion is the 2012 Estate tax provisions since it is just to all players.
Impact of the estate tax on a taxpayer’s ability to transfer wealth to their children
As mentioned in the previous section, the Estate tax is unavoidable. However, there several legal methods that can be used to reduce the impact of the tax burden. The first method is by rescheduling of tax. Under this approach, wealth is transferred to a spouse as a lifetime gift. In this case, it will not be subjected to tax until the death of a spouse. Therefore, this method does not eliminate the estate tax but postpones it. The second method is by executing a uniform transfer. In this case, an estate can be transferred to minors in the form of a gift. In this case, the gift will be managed by a custodian and be transferred once the minors attain the age of majority. The transfer includes Estate tax. The third method is by forming a trust. Two types of trust can be created, these are AB trusts and QTIP trust. Trust has a provision of a unified credit and it provides a more efficient way of minimizing Estate tax. The fourth method is through valuation discounts.
It is a scenario where the assets owned by an individual cannot be valued. Since the computation of taxable amount is based on fair market value, taxing such an asset will not be possible. Therefore, a discount will be levied upon the transfer of such a property. This reduces the amount of estate tax. The fifth approach is by forming a family limited partnership. This method will allow the couple to transfer the family business at a lower tax (income tax) as opposed to the Estate tax. The sixth approach is by transferring some of their wealth to charity since it reduces taxes. The next approach is by transferring the proportion of the estate to irrevocable life insurance trusts. This also reduces the taxable estate. The next approach is through private annuity. In this scenario, the couple can sell a proportion of their estate to their children in exchange for future unsecured pay. The final method is by giving their children a gift worth $24,000 annually. This amount of the gift is not subject to gift tax. This reduces the amount of the taxable estate (Forbes.com LLC, 2013a).
Strategy that can eliminate estate tax
Based on the above analysis, it is evident that there are several legal methods through which the couple can reduce the amount of the Estate tax. An example of an efficient way is creating a trust. This approach will reduce the amount of tax liability by a large amount. Further, the couple will transfer a large amount of their property without losing control of ownership of the Estate. The second strategy that can be used by the couple is transferring some of the amount to an irrevocable life insurance trust. In this case, an equal to life insurance is transferred to the trust. It is also an effective strategy for reducing the amount of Estate tax. Finally, the couple can also gradually transfer a lifetime gift to their children up to a maximum of $24,000 per annum (Forbes.com LLC, 2013b).
Estate tax provision that would most likely to be abused by taxpayers and increase the potential risk of an IRS audit
As discussed in the earlier sections, it is observed that several tax provisions are susceptible to abuse by taxpayers. Therefore, the couple should abuse provisions otherwise they may be exposed to the risk of possible audit by the IRS. One such provision is by reclassifying allowable deductions to suit the requirements of the provisions. In this case, the taxpayer will reduce the amount of the taxable estate by subtracting some of the expenses that are not allowable. In this case, the taxpayer can face the risk of being audited. Thus, provisions that relate to allowable deductions can be easily abused and increase the risk of facing an IRS audit.
Changes that can simplify the estate tax code related to estate taxes
The estate tax code can be made simple with the intention of making it fair to both the taxpayer and the treasury. The first change can be to slightly increase the exemption amount and increase the tax rate. In this case, the federal treasury will gain from the increase in the amount of the tax rate, for instance, from $5.12 million to $5.5 million. On the other hand, the taxpayers will gain by the slight increase in the exemption amount for instance, from $5.12 million to $5.5 million. The second change would be to reduce the businesses that are taxable under the estate tax. These two changes in the Estate tax code will be appealing to the taxpayers. Besides, it will also increase the amount of revenue earned by the federal treasury (Citizens for Tax Justice, 2013).
Based on the discussion above, it is apparent that Estate tax is a major area of concern to taxpayers because they would wish to pass on their entire estates to their descendants. It can be observed that the new Estate tax laws passed in 2012 are a cliff tax to taxpayers. However, the laws contain several loopholes that provide taxpayers with legal ways to either not pay the tax or minimize the amount of tax they can pay. Therefore, Estate tax can be viewed as a voluntary tax.
Anderson, E., Pope, R., & Kramer, L. (2013). Prentice hall’s federal taxation 2013 corporations, partnerships, estates, and trusts: Strayer Custom Edition. US: Prentice Hall – Pearson.
Citizens for Tax Justice. (2013). Max and Dave do Silicon valley. Web.
Forbes.com LLC. (2013a). Rather than tackle tough tax reform, congress focuses on the death tax again. Web.
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Forbes.com LLC. (2013b). Want to avoid the estate tax cliff? Five ways to help. Web.
Internal Revenue Services. (2013). Estate tax. Web.