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Three Important Tax Facts Wealthy People Need to Know

Written by Eva Rosenberg on July 3, 2014 in Tax  |   No comments

Did you go into shock when you saw how the 2014 tax laws affect you? I couldn’t believe how much of a marriage penalty Congress created. We’re back to the bad old days, when my best advice for folks in the top tax brackets was…

three-important-tax-facts-wealthy-people-need-to-knowDid you go into shock when you saw how the 2014 tax laws affect you? I couldn’t believe how much of a marriage penalty Congress created. We’re back to the bad old days, when my best advice for folks in the top tax brackets was to get a divorce.

Divorce can be good for your taxes

I’m only half-joking when I say divorce is a good way to cut down what you owe in taxes. Consider a couple where each person earns $200,000 and together they have mortgage interest and property taxes totaling $40,000. Their federal taxes would exceed $96,000, including that nasty extra 0.9 percent Medicare tax of $1,350.

If the same people were single, however, their separate taxes would not include that extra Medicare hit. Their federal taxes would be about $42,000 each, or $84,000 combined. Voilà—a divorce means an instant federal tax cut of over $12,000.

A divorce for tax purposes doesn’t mean you have to live separately or can no longer enjoy a wonderful relationship. Unfortunately, it does mean that you lose two important estate tax benefits in the event of death: portability and the marital deduction.

Your estate tax exclusion is portable

Portability is a provision in the estate tax law, and it allows a surviving spouse to preserve the unused portion of the estate tax credit and add it to his or her estate. In 2014, the exclusion from estate taxes is $5.34 million.

For instance, if Sally’s husband Joe dies in 2014 with an estate worth $3 million, no estate taxes are due. Sally’s net worth is also $3 million when Joe dies, but after his estate is settled, Sally will be worth $6 million. This means that when Sally dies, she (or her estate) would have to pay taxes on $660,000 at a tax rate of about 37 percent.

However, when Joe passes his $3 million to Sally, he also leaves behind $2.34 million in estate tax exemptions. Sally can add this to her own $5.34 million estate tax exemption amount, which will allow her heirs to exclude over $7.6 million from taxation. In other words, they will probably avoid estate taxes altogether.

To get this benefit, heirs must file Form 706 within nine months of death, even if the estate doesn’t owe any estate taxes.

(Tax facts: How to figure out your tax bracket)

Your marital deduction doesn’t matter to your heirs

Spouses may make unlimited gifts to one another without incurring any gift or estate taxes—even after death. This is a useful way for one spouse to avoid estate taxes when the other spouse dies with an estate worth far more than $5.34 million. To get this benefit, you must use a valid trust or will to transfer everything you own, in excess of the estate tax exclusion limit, to your spouse.

For example, if Joe dies with a $10 million estate, he would use up his $5.34 estate tax exemption, and Sally would not be able to add it to her own estate tax exemption. Her heirs would be forced to pay a lot in taxes when she dies, unless she could dramatically reduce the size of her estate.

But she can’t simply gift away millions of dollars to family and friends because she has to report all large gifts over $14,000 per person. So, what can she do?

Sally could set up a variety of trusts, give gifts with imperfect title, or donate money and assets to charity. She could even set up a charity or foundation that she or her family can control—and, if she chooses, she can even have some real fun with her decisions about those donations. (Where do you think all those foundations that donate to PBS come from?)

Eva Rosenberg, EA is the publisher of TaxMama.com ®, where your tax questions are answered. She is the author of several books and ebooks, including Small Business Taxes Made Easy. Eva teaches a tax pro course at IRSExams.com and tax courses you might enjoy at http://www.cpelink.com/teamtaxmama.

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