SM: Estate Planning Update for Singles

The 2010 tax cut extension package made beneficial changes to the federal estate and gift tax rules for 2012. That's good news, but your estate plan may need an update to take advantage of the benefits. Here's what unmarried individuals need to know.

The New Rules in a Nutshell

The federal estate tax exemption is now a whopping $5.12 million for estates of individuals who die in 2012. A flat 35% tax rate applies to the value of an estate in excess of the $5 million exemption.

The federal gift tax exemption is also set at $5.12 million for 2012. Gifts in excess of the $5.12 million exemption will be taxed at a flat 35% rate.

Single With Estate of Less Than $5.12 Million

If your estate is worth less than $5 million and you depart this world in 2012, everything you own can be left to relatives and loved ones without any federal estate tax hit.

However, your current estate planning documents may be out of date. For example, they might direct the executor of your estate to make enough charitable donations to get the value of your estate below the much-smaller federal estate tax exemption amounts that applied in bygone years ($2 million for 2006-2008; $3.5 million for 2009). If so, the bigger $5.12 million exemption that's now in place allows you to leave more to relatives and loved ones (and less to charity) without any federal estate tax hit.

Single With Estate of More Than $5.12 Million

You might want to change your estate planning documents to direct the executor to give away more to IRS-approved charities in order to get your taxable estate below the $5.12 million. Of course, increasing such donations means leaving less to relatives and loved ones.

Other things you can do to reduce your taxable estate include:

1. Make annual gifts of up to $13,000 to relatives and loved ones. Thanks to the annual federal gift tax exclusion ($13,000 for 2012 and probably the same for 2013), such gifts reduce your taxable estate but they don't reduce your $5.12 million federal estate tax exemption or your $5.12 million lifetime federal gift tax exemption. For example, say you have two adult children and four grandkids. You could give them each $13,000 in 2012 for a total of $52,000 (4 x $13,000). Then you could do the same thing next year. This strategy would quickly reduce your taxable estate by $108,000 with no adverse tax effects.

2. Pay college tuition expenses (not room and board) or medical bills for relatives and loved ones. You can give away unlimited amounts for these purposes without reducing your $5.12 million federal estate tax exemption or your $5.12 million lifetime federal gift tax exemption--as long as you make the payments directly to the college or medical service provider. You can do this yearly.

3. Give away appreciating assets while you're still alive. Thanks to the generous federal gift tax exemption for 2012, you can give away up to $5.12 million of appreciating (we hope) assets like stocks and real estate right now without triggering any federal gift tax hit. This can be on top of cash gifts that take advantage of the $13,000 annual exclusion and on top of cash gifts to directly pay college tuition or medical expenses. If you make gifts that chip away at your $5 million federal gift tax exemption, your $5.12 million federal estate tax exemption is reduced dollar-for-dollar. For example, say you give $100,000 worth of stock to a favorite relative this year. That would use up $87,000 of your $5.12 million gift tax exemption ($100,000 $13,000 annual gift tax exclusion) and $87,000 of your $5.12 million estate tax exemption. But making gifts that utilize your exemptions is OK if you're giving away appreciating assets--because the future appreciation will be kept out of your taxable estate.

Stay Tuned for Further Developments

As things now stand, the new taxpayer-friendly federal estate and gift tax rules will only be in place through the end of 2012. What happens in 2013 and beyond will probably depend on how the 2012 election turns out. If the current rules are allowed to expire, you'll be facing a confiscatory federal estate tax regime for 2013 and beyond--with only a $1 million exemption and a maximum estate tax rate of 55%. Similarly, the federal gift tax exemption would fall back to only $1 million, and the maximum gift tax rate would jump to 55%. Depending on what transpires, you may have to update your estate planning documents again to reflect the rules that will apply for 2013 and beyond. Meanwhile, you should huddle with your professional adviser to optimize your estate plan under the rules that apply right now.