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By Christine Benz | 01-09-2013 11:00 AM

How to Stay Smart With Your Estate Plan

Estate-planning expert Deborah Jacobs outlines how to approach the estate tax exemption and gift tax rules, addresses a popular misconception about estates, and offers key documents that all individuals should have in place.

Note to readers: This video originally posted on Jan. 24, 2013. We are refeaturing it as part of Morningstar.com's Tax-Relief Week 2013.

Christine Benz: Hi. I am Christine Benz for Morningstar.com. The recently enacted tax package included some provisions affecting the estate tax. Joining me to discuss these provisions is Deborah Jacobs. She is an estate-planning expert. Deborah, thank you so much for being here.

Deborah Jacobs: Thank you for having me.

Benz: We were set to see some really substantive changes in the estate tax laws, but the new tax package really didn't change a lot. Let's talk about what's changing and importantly, what is staying the same in the realm of estate taxes?

Jacobs: Well, I think the headline is almost nothing changes for you. The only thing that really is different from the system that we've had in place for the last two years is that the tax rate for people who are subject to tax has gone up from 35% to 40%, but in point of fact, very few people have to worry about taxes anymore. So, that's a huge relief. The threat was that more people were going to be subject to tax because when the Bush-era tax cuts expired, it meant that we were going to have an automatic tax hike. But in point of fact, the amounts that are tax-free are the same as they have been for the last two years.

Benz: So it was poised to go to $1 million exclusion amount, which would obviously begin to affect a lot more people. Now that exclusion amount will rise to $5 million-plus. Let's discuss, Deborah, what that exclusion amount is specifically, and also how does that relate to lifetime gifts that someone might make? How do those two limits work together?

Jacobs: Well, I think this is the area in which there is the greatest confusion out there and part of it is terminology. When we say the exclusion from estate tax, there are a few different terms that are kicking around. Some people call it the basic exclusion, some people call it the unified credit, some people call it the exemption, which is a more familiar term. It's the tax-free amount. It's the amount that you can pass either during life or when you die without there being any tax to pay.

If you go over that amount during your life, it's called gift tax, and you must pay it. A common source of confusion is the person making the gift pays the tax, not the gift recipient. On the other hand, if you pass it through your estate, your heirs must pay it, and at that point it's called estate tax and it's that tax that's now 40%.

The exclusion or the exemption whether you use it during your life or when you die refers to transfers that would otherwise be subject to tax. So, we called them taxable gifts. There is a whole separate category of ways to give assets away in the form of what are not considered taxable gifts. The way you do this is by using what's called the annual exclusion, and again, the terminology gets a little confusing because we're using the word exclusion in both contexts.

The annual exclusion is the amount that each of us can give away to an unlimited number of people without it being considered a taxable gift, and that amount, which has gone up in 2013, is currently $14,000 a year. So, Christine, I could give $14,000 a year to you, to each of your siblings, to each of your children, to your husband to an unlimited number of people, and if you're married, you can combine your two amounts and give away $28,000 to as many people as you want each year without it being subject to tax.

You can give this amount away by writing a check, you can give away a piece of jewelry, you can give away a piano, you can put money into a trust, you can put money into a 529 education savings account. There are many, many ways to use the annual exclusion, most people just write a check.

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