Tennessee Class B Gift Tax

Posted on October 7, 2010 by Bryan Howard

One of my clients called me today with a complaint about his Tennessee Class B Gift Tax. In 2009, he made a gift of $13,000 to his step-granddaughter. She had a tough year, including losing her job and getting divorced. $13,000 is the amount of the annual exclusion for federal gift tax purposes and Tennessee gift tax purposes for certain donees.

As a general rule, gifts that do not exceed the annual exclusion are exempt from gift tax. The problem is that Tennessee categorizes some donees as “Class B” beneficiaries. Class B beneficiaries consist of step-grandchildren, sisters-in-law, brothers-in-law, nieces, nephews, as well as persons who are not related to you.  Tennessee only allows you to make an annual exclusion gift of $3,000 per Class B beneficiary or $5,000 if you only make a gift to one Class B beneficiary.

Because my client’s step-granddaughter was the only Class B beneficiary to whom he made a gift, he owed tax of 6.5% times $8,000, or $520. My client was chapped because he was being “punished” for being generous to his step-granddaughter. In 2010, his gift to his step-granddaughter will only be $5,000.

Most people characterize the Class B gift tax as a silly tax. I suspect that it brings in less than $50,000 per year to the State. There have been numerous proposals to abolish the Class B distinction so that tax-free gifts of $13,000 can be made to anyone. Every time that a proposal is made, a fiscal note is attached to the bill and it never goes anywhere due to the fiscal note.

If you are making gifts to collateral relatives, you should consider limiting the gift to $3,000 per donee, or $5,000 if you are only making gifts to one Class B donee during the year if you want to avoid the Class B gift tax.

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Tennessee Inheritance Taxes Are Cheaper Than Federal Capital Gains Taxes

Posted on November 2, 2009 by Bryan Howard

The estates of a lot of Tennessee decedents pay Tennessee inheritance taxes but do not pay federal estate taxes. The federal estate tax exemption is currently $3.5 million. As of the date of this article, various members of Congress favor extending this exemption amount indefinitely into the future. The Tennessee inheritance tax exemption is currently $1 million. There does not appear to be much likelihood that Tennessee will increase its exemption to match the federal exemption.

The difference between the federal and Tennessee exemptions means that unmarried decedents who die with a taxable estate with a value between $1 million and $3.5 million will pay Tennessee inheritance taxes but not federal estate taxes. There are several things that can be done to reduce the value of assets for Tennessee inheritance tax purposes.

Some of these steps can be taken shortly before death. As an example, a parent might make a deathbed gift of a fractional interest in real property to a child with the goal of capturing a fractional interest discount for the remaining portion of the property when the parent dies. There are also various post-mortem decisions that can affect the value of the assets owned by the estate.

Even though the estate is not subject to federal estate taxes, the date of death value of the assets becomes the basis of the assets for federal income tax purposes. Basis will be relevant when the estate or the beneficiaries later sell the assets. Federal capital gains taxes are 15% and are scheduled to increase to 20% in the year 2011. If the beneficiaries live in a state outside of Tennessee that imposes a capital gains tax, this will make the capital gains tax rate even higher. The maximum Tennessee inheritance tax rate is 9.5%.

Since capital gains tax rates are higher than the maximum Tennessee inheritance tax rate, it is generally not advisable to take steps that reduce the value of the decedent’s assets for Tennessee inheritance tax purposes, unless it is known that the beneficiaries will continue to own the assets in the estate for several years. The reduction in the value of the estate will increase capital gains taxes by more than the Tennessee inheritance taxes that are saved.

Making tax-free annual exclusion gifts is still a good idea. It is better to give cash as opposed to an appreciated asset that will receive a free basis increase upon death. A cash gift reduces Tennessee inheritance taxes without increasing capital gains taxes.
 

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