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DEATH TAXES AND ESTATE PLANNING
CAPT. JERRY R. SIEFERT, USN*
[The following article was published in the September 1962 issue of the JAG JOURNAL but was inadvertently omitted from the index. A mounting number of requests for the information contained therein demanded that it be republished in order to bring it to the attention of interested personnel.]
VERYONE HAS HEARD of estate and in
heritance taxes, but since death and taxes are subjects no one likes to think about, and because many believe that death taxes are of concern only to the wealthy, they are not given much thought. It may be that many military and naval personnel do not have estates large enough to justify any great concern for federal or state death taxes, but a death tax has been a permanent feature of the National tax system since 1916 and of practically every state tax system for almost that long. Since 1931, Nevada has been the only state without such a tax; and the overlapping of state and national taxes on transfers of property at death, imposed either on the estate of the decedent or on the shares of his heirs, has been almost universal for over a generation. Governments in the United States currently derive about $2 billion a year from inheritance, estate, and gift taxes.1
Under present tax laws, it is not unusual for a provident member of the Armed Forces to build up an estate that will incur estate and inheritance taxes on his death. This conclusion is more readily understandable when the types of property going to make up an individual's “estate” are listed, but first, the technical difference between an estate and inheritance tax should be explained.
posed upon the transfer of the entire taxable estate and not upon any particular legacy, devise or distributive share." 2 After certain deductions and exemptions the tax is determined according to the total amount of property, real, personal or mixed, left or transmitted by the deceased for the benefit of his heirs or benefici. aries. An inheritance tax, on the other hand, is a tax imposed on the right to receive property. Technically, it is a tax on the survivors' right to receive property of a deceased and is measured by the amount being inherited, by individuals or classes of individuals.
The majority of the states impose “inheritance" type taxes and exemptions vary according to the degree of relationship to the deceased. For example, under Virginia law there is a $5,000 exemption for each of those in what is called "Class A”, which includes father, mother, grandfathers, grandmothers, husband, wife, children by blood or by legal adoption, stepchildren, grandchildren and all other lineal ancestors and lineal descendants. A $2,000 exemption applies to those in “Class B" which includes brothers, sisters, nephews and nieces. “Class C” includes all others and the exemption is $1,000.3
To illustrate how exemptions vary among states, under California law the first $12,000 going to a minor child of the deceased is exempt. The first $5,000 transferred to the spouse of the decedent, to lineal issue and ancestors, and to certain others is exempt; and in addition, none of the community property willed to the surviving spouse is subject to the California inheritance tax unless a life estate or special power of appointment in such property is created. California provides varying lesser exemptions for three additional classes of beneficiaries down to a $50 exemption for property passing to strangers and distant relatives.
In addition to inheritance and estate type taxes, a number of states have what is called a "pick-up" tax. This is also referred to as an estate tax, but basically it is a tax, usually in addition to the inheritance tax, imposed to take full advantage of the maximum credit allowed by the Federal estate tax law. If the basic state
TYPES OF DEATH TAXES
An estate tax, such as the Federal estate tax, is not a tax on property, but is a tax on the right to transmit property at death and is measured by the value of the property. "It is a tax im
*Captain Jerry R. Siefert, U.S. Navy, is presently serving as Director,
on Intergovernmental Relations on “Coordination of State and
2. P-H Fed. Est. and Gift Taxes Vol., $ 120,002.
BENEFITS SUBJECT TO TAX
inheritance or estate tax, as the case may be, is less than the maximum credit allowable under the Federal estate tax law for taxes paid to a state, the state "pick-up” tax increases the tax due the state so that it will equal the maximum credit allowed under the Federal law. The overall cost to the estate or to the beneficiaries is therefore not increased by the “pick-up” type tax.
Depending on state statutes, inheritance taxes are usually chargeable to the benefits on which that type tax is assessed or measured. Estate taxes are generally paid from the residuary estate, but the laws of the state where an estate is probated or administered may require that the estate tax be apportioned among all the beneficiaries in ratio to the benefits received. Uncertainty in the apportionment field can be minimized by testator's specifying in his will which funds are to be used to pay death taxes. The will could provide, for example, that all federal and state death taxes be paid out of the residuary estate, without apportionment among specific devisees or legatees; or that all death taxes be paid from a particular trust fund or from insurance funds set up for that purpose.
As a matter of statistics, at the time of writing, 35 states have an inheritance tax and a "pick-up” tax, 3 states have an estate tax and "pick-up" tax (New York, Mississippi and Oklahoma), 5 states have a "pick-up" tax only (Florida, Georgia, Alabama, Arkansas and Arizona), 5 states an inheritance tax only or an estate tax only (Oregon, Utah, North and South Dakota, and West Virginia), Rhode Island has inheritance, estate and “pick-up” taxes, and Nevada has no type of death tax.5
Most people realize that intangible personal property such as stocks, bonds, savings accounts, checking accounts, notes, etc., registered in the name of an individual or bearer securities in the possession of an individual at time of death, and any real or tangible personal property owned by him, would be part of his estate and subject to applicable death taxes. What is commonly overlooked is that there are other benefits that heirs become entitled to by reason of death; and that it is the appreciated value of property as of the date of death that normally controls for tax valuation, not the purchase price.
Other benefits usually passing to a widow or children of a serviceman upon his death, which are included within his estate for purposes of determining whether a federal estate tax return must be filed, include: the full value of jointly owned real and personal property, except such part thereof as may be shown to have originally belonged to the other or surviving joint owner and was never acquired from the decedent for less than full consideration in money or money's worth; ? insurance proceeds payable on death of the insured serviceman are included within his estate unless it is payable to some beneficiary other than the estate and the insured had no incidents of ownership in the policy (right to cash it in, borrow on it, change beneficiaries, etc.) ; & insurance proceeds subject to tax include National Service Life and Government Insurance; arrears in pay paid to a widow or beneficiary are part of the estate; and if the serviceman has retired, the value of benefits under the Retired Serviceman's Family Protection Plan (formerly Contingency Option Act) is included for Federal estate tax purposes. The value of benefits under the Family Protection Plan is determined by the age of the recipient at the time of the death of the member and the amount the recipient or beneficiary receives. "Present Worth" tables are used to determine the estate tax factor, and that factor multiplied by the annual amount to be received, gives the value of the annuity which at present must be included in the deceased member's gross estate for estate tax purposes. For example, if the 6. Under section 2032 of the Internal Revenue Code of 1954 [26
U.S.C. $ 2032 (1958)] the executor may elect to value a decedent's gross estate at a date other than the date of decedent's death. This section spells out the procedure for making an election and specifies the applicable dates that may be used to lessen the amount of the tax when, within the year following the decedent's death, the gross estate has suffered a shrinkage in its aggregate
value. 7. IRC 1954, section 2040, 26 U.S.C. $ 2040 (1958). 8. IRC 1954, section 2042, 26 U.S.C. $ 2042 (1958). 9. Rev. Rul. 55–662, CB 1955–2, p. 385.
FEDERAL ESTATE TAX
The Federal estate tax, applicable in the case of U.S. citizens or residents, is the tax that is usually given most attention in estate planning, and is imposed on the taxable estate. The term "taxable estate" refers to the total gross estate left by a deceased, less all deductions and the basic $60,000 exemption. When this figure is mentioned to service personnel, the usual reaction is, “Well I don't have $60,000, so I don't have to be concerned with estate taxes.” If the “taxable estate" you leave were limited to money in the bank, or invested in securities, car and house, you might be safe in not studying the problem further, but those are not the only property interests taken into consideration in arriving at the amount known as the "taxable estate.”
5. See note 1 supra,
since the above benefits are not part of the estate of a deceased serviceman, but a benefit paid by the government to his surviving widow, children or dependent parents, such benefits should likewise not be part of his estate for purposes of state death taxes. The Attorney General of Oregon, however, has stated in an opinion of 20 May 1963 (CCH, Oregon Tax Rep. & 201– 397), that Oregon may lawfully impose inheritance taxes on the value of those federal social security benefits in excess of the $10,000 exemption specified in the Oregon law notwithstanding that by federal law social security benefits are not subject to federal estate taxation. He reasons that an inheritance tax is not a tax upon the property itself, but on the succession and right to take property. The Attorney General cites U.S. Trust Co. v. Helvering (1939) 307 U.S. 57, as authority for his position by reason of holding that federal bonds exempt by statute from all taxation are nevertheless subject to a federal inheritance tax.
annuity benefits payable to a beneficiary total lerson
$3,000 per year and the present worth tables, count
(not a life expectancy table) based on the age 1 in the of the beneficiary at time of death of the mems in the ber, give a factor of 10, the value of the annuity ith, an
for estate tax purposes would be $30,000. In vned to the case of a retired flag or general rank officer bject t who has elected the maximum one-half benefit nmont
for his wife and if the wife is relatively young at its tha date of his death, the benefits to her under the th; an Family Protection Plan could be valued at over
$70,000.10 This tax impact of death taxes on Protection Plan benefits is considered inequi
table. At the time of writing, the Treasury dow o Department has agreed with DOD that the best , whic! solution to correct the status of Protection Plan oses o
benefits is legislation. A detailed study is in tax ré
process and Treasury Department action is exalue of pected in the near future. Department of Dety, ex fense legislative proposal 88-50, Retired Servto have iceman's Family Protection Plan, Amend to *viving Provide Tax Exemption, presently pending om the before the Bureau of the Budget, will be ion ir amended and forwarded to Congress. oceeds
Other miscellaneous type items that may be an are included in a decedent's gross estate, even ayable though in some instances they might not be te and items subject to probate procedures or subject in the to provisions of a will, are the following: gifts hange or certain property transferred during his lifeubject time without adequate consideration, property overn over which the decedent had a general power of vidow appointment,11 annuities, dower or curtesy of a if the surviving spouse or a statutory estate in lieu enefits thereof, debts due the decedent, interests in busirotec ness, insurance on the life of another, accumuAct) is lated dividends, post mortem dividends and re
The turned premiums on insurance, claims, rights, ection royalties, leaseholds, reversionary interests, cipient household and personal effects, etc.12
Benefits paid to survivors after death of a ceives serviceman which are not part of his estate, for ermine federal estate tax purposes, include pensions or tiplied compensation paid to survivors by the Veterans es the Administration ; 18 Armed Forces gratuity pay,
which was held not to constitute property of the decedent for federal estate tax purposes; amounts payable under the Social Security Act to the widow, children, or parents of a “fully insured" or "currently insured” decedent,15 and 10. For a detailed discussion of COA or Protection Plan benefits [10
FILING OF FEDERAL RETURNS A federal estate tax return must be filed for the estate of every citizen or resident of the United States whose gross estate, including all types of property described by statute, such as that discussed above as being subject to tax, exceeded $60,000 in value at the date of death.16 The return must be filed within 15 months after the date of the decedent's death, even though there may be no tax due because of deductions and exemptions."
The property left by a deceased may be subject to claims for debts, medical and funeral expenses, expenses incurred in administering property subject to claims and for mortgages and liens. The administrator or executor of the estate is liable for paying such claims against the estate and these payments are deducted from the gross estate, leaving what is called the "adjusted gross estate.” The marital deduction, if any, is deducted from the adjusted gross estate and the $60,000 basic exemption is then deducted to arrive at the "taxable estate."
U.S.C. $8 1431-1446 (1958)), see JAG JOURNAL of March 1961,
"The Tax Impact of the Contingency Option Act."
$ 3101 (1958).
1954 12 Hecedenti t's death ction and essen the Secedenti aggregat
MARITAL DEDUCTION One of the most important deductions available to estate planners for the purpose of avoiding federal estate taxes is the marital deduction provided by section 2056 of the Internal 16. IRC 1954, 26 U.S.C. $ 6018 (1958); Reg. section 20.6018-1 (1962). 17. IRC 1954, section 6075, 26 U.S.C. $ 6075 (1958). Also, a pre
liminary notice must be filed within two months of decedent's death if no executor or administrator qualifies within that period; or if one qualifies, within two months of death, the preliminary notice must be filed within two months of the qualification. 26 U.S.C. $ 6071 (1958); (Treas. Reg. $ 20.6071-1) (1962).
Revenue Code of 1954. The maximum marital deduction allowable is equal to one-half of the adjusted gross estate. To qualify, property must pass to the surviving spouse either outright or as a life interest with a general power of appointment. As mentioned above, the "adjusted gross estate" is generally the gross estate less debts and administration expenses. If full advantage is taken of the marital deduction, an adjusted gross estate would have to be over $120,000 before there would be any federal estate tax assessed.
The technicalities surrounding the "marital deduction" could be the subject of several JAG JOURNAL articles, but in brief, if the surviving spouse, man or woman, has only a life interest with no right or power to say who gets the corpus or principal upon his or her death, or if the surviving spouse's interest is "terminable" or could be terminated by certain occurrences, such an interest would not qualify for the marital deduction. Interests which qualify for the deduction, however, are not limited to property received outright under a will. For example, life insurance proceeds payable to a surviving spouse may qualify; a survivor's rights in jointly owned property or property owned by entirety could qualify; dower and curtesy rights or a statutory interest in place of such rights could qualify; benefits payable under option 1 (to wife) or 1 and 4 (added provision 4 to terminate withholdings if wife dies first) of the Retired Serviceman's Family Protection Plan (formerly COA) would qualify for the marital deduction, but option 2 (benefits for children) would not; the option 3 benefits (wife and children) under the Protection Plan would probably qualify for marital deduction benefits if there was no eligible child on the date of death of the member, since all possible benefits would be the widow's.18
of property, an estate of about $155,000 will be used. Assuming debts, doctor bills, funeral and administration expenses are approximately $5,000, a gross estate of $155,000 would be reduced to $150,000. This $150,000 is referred to as the "adjusted gross estate." It is this amount which determines the maximum marital deduction. Everything left to the surviving spouse up to the maximum of one-half of the adjusted gross estate, as mentioned above, qualifies for the deduction. This leaves $75,000 from which is deducted the basic $60,000 exemption, leaving $15,000, which is the "taxable estate." The federal estate tax on $15,000 would be $1,050.
Suppose, on the other hand, that insurance was made payable so that all the surviving spouse receives is a life interest, that the benefits payable under the Family Protection Plan option 3 do not qualify for the marital deduction, and that all other property was left in trust, income to wife, remainder to children, so that no appreciable amount of property qualifies for the marital deduction. The only deduction from the $150,000 adjusted gross estate would be the $60,000 basic exemption, leaving a taxable estate of about $90,000. The tax on that amount would be $17,900, or $16,850 more than if full advantage had been taken of the marital deduction.
Taking full advantage of the marital deduction may not always be the best estate planning so far as taxes are concerned. This is illustrated by an example given in Prentice-Hall Executives Tax Report of November 13, 1961: Assume a husband has an estate of about $120,000 and his wife has a separate adjusted gross estate of about $80.000. If the husband dies first, taking the maximum marital deduction by leaving $60,000 to his wife and the rest to his son, and if the wife dies later leaving all to their son, the son eventually gets $184,900. If the husband and wife each leaves everything directly to their son, he gets $188,900. But, if the husband takes a marital deduction of only $20,000 by leaving that amount to his wife, the son eventually gets $190,400.
STATE DEATH TAXES As mentioned earlier, most attention in estate planning is directed toward the Federal estate tax, but state death taxes should not be ignored. In general, it is the state of domicile of the deceased where a will is probated or an estate is administered, where the death tax will be assessed; however, if real property is owned in states other than the deceased owner's domicile
MARITAL DEDUCTION ILLUSTRATED The value of the marital deduction for federal estate tax purposes is best shown by an example. The tax brackets for the tax range from 3% to 77%, so the relative effect or benefit of any deduction increases with the size of the taxable estate. To limit the example to a realistic estate for a serviceman who has invested well or has inherited a moderate amount
18. P-H Fed., Est. and Gift Taxes Vol., § 120,570 (50) lists property
interests qualifying for the marital deduction and cites IRS Letter, 5-12-49, as follows:
Marital deduction is allowable for annuity paid to surviving spouse under retirement or pension plan where all amounts payable under the contract are receivable by the spouse and terminate with her death, and no other person may thereafter possess or enjoy any part of the property.