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Annual Exclusion Gifts and the Tennessee Tax Trap
March 1, 2009
By: Joy Dixon Wilman
As each new year generally brings changes in various federal and state tax exemptions and exclusions, 2009 sees an increase in both the federal gift tax annual exclusion amount and the federal estate tax exemption amount. This update highlights those changes and discusses potential tax traps that may affect your current estate plan.
As each new year generally brings changes in various federal and state tax exemptions and exclusions, 2009 sees an increase in both the federal gift tax annual exclusion amount and the federal estate tax exemption amount. This update highlights those changes and discusses potential tax traps that may affect your current estate plan.
Gift Taxes
Federal. The annual federal gift tax exclusion has increased from $12,000 to $13,000 per donee. This federal gift tax annual exclusion refers to the amount that one individual (the "donor") can give to another individual (the "donee") in a single year without the gift being subject to federal gift taxes. The exclusion is calculated on a per donee basis – so a donor can make separate annual exclusion gifts to multiple donees. For example, a father with children could make separate gifts to each child without triggering a federal gift tax.
The federal laws also allow an individual to use $1 million of his or her federal estate tax exemption (currently $3.5 million) to cover taxable gifts made during the individual's lifetime. So, if the father in our example made a one-time $1 million gift to his favorite daughter (in addition to the annual exclusion gift of $13,000), he could do so without triggering a federal gift tax.
Tennessee. Tennessee residents enjoy the same annual gift tax exclusion for state gift taxes, provided that the gift is made to "Class A" beneficiaries - spouses, descendants, ancestors, siblings, sons-in-law, daughters-in-law, and stepchildren. This year, the Tennessee annual gift exclusion has increased from $12,000 to $13,000 per Class A beneficiary. However, gifts to other beneficiaries ("Class B" beneficiaries) qualify for a much smaller Tennessee gift tax annual exclusion of $3,000.
This distinction between Class A and Class B beneficiaries is a potential tax trap for Tennessee residents who base their gifting on the federal gift tax annual exclusion. Generally, a gift to a Class B beneficiary of $13,000 would trigger a Tennessee gift tax on the $10,000 given in excess of the $3,000 Class B beneficiary exclusion amount. The Tennessee gift tax statutes do provide for a single annual $5,000 Class B standard deduction applied to the first $5,000 Class B gift, which would reduce the amount subject to the gift tax in the above example to $8,000. Additional Class B gifts for the year would only be permitted to take the $3,000 per Class B donee exemption.
A second potential tax trap for Tennessee residents is the absence of a lifetime gift tax exemption. As such, if the father described above made a $1 million gift to his daughter, it would be eligible for a federal gift tax exemption but would be subject to Tennessee gift tax on $987,000 - the amount by which the $1 million gift exceeds the $13,000 per year Class A beneficiary annual exclusion amount.
Estate Taxes
Federal. The federal estate tax exemption amount has also increased from $2 million to $3.5 million. With proper planning, a married couple can now transfer up to $7 million to non-charitable beneficiaries without incurring any federal estate tax. However, unless Congress acts on the matter, current law prevents the "portability" of the estate tax exemption, meaning that one spouse cannot use any of the other spouse's exemption. So, if a decedent dies without using all of his estate tax exemption, the remainder is essentially lost, because his surviving spouse cannot apply any of the remainder to her estate.
Tennessee. The Tennessee inheritance exemption is currently $1 million. With the federal exemption at $3.5 million, a $2.5 million gap exists for Tennessee residents. The effects of the lower Tennessee exemption may be remedied, however, by appropriate estate planning. For example, the establishment of a credit shelter trust and a marital deduction trust under a decedent’s Will can often cause a decedent's estate to defer, if not avoid, payment of the Tennessee inheritance tax.
The Year 2010
It is important to note that all of the changes described above are only applicable in 2009, because the federal estate tax is scheduled to be repealed in 2010 under current law. The repeal is scheduled to be effective for only one year, after which time the federal estate tax is scheduled to be reinstated in 2011. If the repeal occurs, there may be drastically different treatment of estates for decedents who die in the years 2009, 2010, and 2011. It is very likely that Congress will act in the meantime to eliminate the repeal.
The potential uncertainty in the federal estate tax rules highlights the need for clients to have their estate plans reviewed on a regular basis.