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2016 update for Federal and Montana estate taxes, gift taxes, and generation-skipping transfer taxes

Posted on: March 31st, 2016
The Internal Revenue Service has released the official inflation adjustments that will affect 2016 federal reporting for estate taxes, gift taxes, generation-skipping transfer taxes, and estate and trust income taxes. Remember, that although Montana does have an state estate tax, its computation is broken.  Thus in reality Montana does not have a state estate tax.  

2016 Federal Estate Tax Exemption

In 2016 the estate tax exemption will be $5,450,000. This is an increase of $20,000 over the 2015 exemption and a total increase of $1,950,000 since 2009. The maximum federal estate tax rate remains unchanged at 40%.

What this means is that a person can die in 2016 with up to $5,450,000 of assets before his or her estate will need to file an estate tax return. Of course, there are certain circumstances where an estate tax return will still be necessary - such as to elect 'portability', make a QTIP election, or if a person made substantial gifts during their life. The exact deadline to file an estate tax return varies depending on a person's date of death, because an estate tax return is due within nine months of the deceased person's date of death.

Although the estate tax exemption has been increasing and now generally means that most people don't need to worry about estate taxes, almost everyone still needs a will or a trust to ensure that their assets pass to their intended beneficiaries.

If a person makes any taxable gifts in 2016 (in general a taxable gift is one that exceeds the annual gift tax exclusion - see more on that below), then they will need to file a federal gift tax return. For taxable gifts made in 2016, the gift tax return is due on or before April 17, 2017 (the same day as your 2016 income taxes).

2016 Federal Generation-Skipping Transfer Tax Exemption

In 2015 the exemption from generation-skipping transfer taxes (GSTT) will also be $5,450,000. This is an increase of $20,000 over the 2015 exemption and a total increase of $1,950,000 since 2009. The maximum federal GSTT rate remains unchanged at 40%.

What this means is that if a person makes any transfers that are subject to the GSTT in 2016, then they will need to file a federal gift tax return. For generation-skipping transfers made during 2016, the gift tax return is due on or before April 17, 2017 (the same date as your income taxes for 2016). If the generation-skipping transfer does not exceed $5,450,000, then no GSTT will be due; instead, the transferor's GSTT exemption will be reduced by the amount of the transfer.

For example, if Bob has not made any prior generation-skipping transfers and makes one of $500,000 in 2016, then his GSTT exemption will be reduced to $4,950,000 ($5,450,000 GSTT exemption - $500,000 generation-skipping transfer = $4,950,000 GSTT exemption remaining). The generation-skipping transfer tax is a complex tax, so you'll definitely want to check with your accountant and attorney before making any large gifts during 2016 (or 2015 for that matter).

2016 Annual Gift Tax Exclusion

In 2016, the annual gift tax exclusion will remain at $14,000. However, one adjustment is happening next year - the first $148,000 of gifts to a spouse who is not a U.S. citizen are not included in the total amount of taxable gifts. This is an increase of $1,000 above the 2015 exclusion.

Here's how the annual gift tax exclusion works. If you make gifts to the same person that are $14,000 or less, then no gift tax return will probably be necessary. However, if the gifts to one person exceed $14,000 in 2016, then you'll need to file a federal gift tax return. For taxable gifts made in 2016, the gift tax return is due on or before April 17, 2017 (the same day as 2016 income tax returns).

If the taxable gift does not exceed $5,450,000, then no gift tax will be due; instead, the lifetime gift tax exemption of the person who made the gift will be reduced by the amount of the taxable gift.

For example, if Bob has not made any taxable gifts in prior years and makes a gift of $500,000 to his daughter in 2016, then Bob's lifetime gift tax exemption will be reduced to $4,964,000 ($500,000 gift - $14,000 annual exclusion = $486,000 taxable gift; $5,450,000 lifetime gift tax exemption - $486,000 taxable gift = $4,964,000 lifetime gift tax exemption remaining). As you can see, the interplay between the annual gift tax exclusion and the gift tax exemption can become complex once you add multiple gifts and recipients, so you'll want to check with your accountant or attorney before making any substantial gifts.

2016 Estate and Trust Income Tax Brackets

Finally, estates and trusts will be subject to the following income tax brackets in 2016:

If Taxable Income Is: The Tax Is:

Not over $2,550 15% of the taxable income

Over $2,550 but $382.50 plus 25% of
not over $5,950 the excess over $2,550

Over $5,950 but $1,232.50 plus 28% of
not over $9,050 the excess over $5,950

Over $9,050 but $2,100.50 plus 33% of
not over $12,400 the excess over $9,050

Over $12,400 $3,206 plus 39.6% of
the excess over $12,400

The income tax rates for estates and trusts are very compressed. An estate or trust will hit the top 39.6% rate at only $12,400 of taxable income in 2016. Estates and trusts are also potentially subject to the 3.8% net investment income tax (on top of the above rates), depending on their income level and source of income.

Bottom line: if you're a trustee or executor, you should talk to your accountant and attorney now to ensure that you're making the most income tax efficient decisions possible given the circumstances of the estate or trust.
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