The implementation of the Economic Growth and Tax Relief Reconciliation Act of 2001, which both increased the Federal estate tax exemption and more importantly eliminated the state estate tax credit, started the process of "decoupling" between the Federal estate tax and various states. As the years moved forward, many states retained a $1 million estate tax exemption amount, decoupling their exemption from the Federal amount that has ultimately risen to its current $5 million level. However, the reality is that a second decoupling just occurred in 2011 - the decoupling of state estate tax exemptions from the Federal gift tax exemption. As a result, a new state estate tax planning "loophole" has opened up, creating a planning opportunity for many clients... but only until the states close the loophole.
To understand the loophole, it's important to understand the purpose of the gift tax itself. Contrary to what many realize, the primary purpose of the gift tax is not really just to tax gratuitous transfers of property from one person to another. Its real purpose is to provide a backstop to the estate tax, by providing a mechanism that prevents taxpayers from simply trying to dodge the estate tax by giving all their money away before they die.
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