Estate planning in essence involves arranging for postmortem gift giving. When you hear about the existence of the estate tax, you may wonder if it is possible to accelerate this gift giving. Perhaps you can give the gifts while you are still alive to avoid estate taxes.
For several years after the enactment of the estate tax 1916, this was actually possible. However, a gift tax was enacted to close this loophole, and it remains in effect to this day.
Let’s look at the gift tax and how it affects your ability to give tax-free gifts to your loved ones.
Annual Gift Tax Exclusion
The federal gift tax is unified with the estate tax. The maximum rate of the gift tax is 40 percent.
However, you are not immediately faced with a 40 percent transfer tax if you give your daughter an iPad for her birthday, because there is an annual per person gift tax exclusion.
Under Internal Revenue Service regulations, you may give gifts totaling as much as $14,000 per person to any number of others within a calendar year free of the gift tax.
There is no limit to the overall amount, as long as you don’t give more than $14,000 to any one person within a year.
Unified Gift and Estate Tax Exclusion
In addition to the annual gift tax exclusion, there is a lifetime unified gift and estate tax exclusion. The amount of this exclusion stands at $5.45 million in 2016.
If you gave gifts to someone that exceeded $14,000 within a calendar year, you could still give the gifts tax-free. This can be done by using a portion of your unified exclusion.
For example, if you gave your son $14,000 today, this gift could could be given tax-free because of the annual gift tax exclusion.
Let’s say that you win the lottery next week. Your son wants to buy a house, and he has negotiated a price of $2.45 million. You could use some of your unified lifetime exclusion to give him the $2.45 million that he needs to buy the house tax-free.
Your total exclusion was $5.45 million. You will subsequently have $3 million of your unified lifetime exclusion remaining to apply to future gifts and the value of your estate as it is being transferred to your heirs after you die.
Mitigate Exposure to Estate Taxes
People who expect to pass away in possession of assets exceeding $5.45 million in value are faced with estate tax exposure. As a result, those who are in this position must implement tax efficiency strategies.
There are various different ways that you can position your assets to mitigate your exposure. Utilization of the annual gift tax exclusion can be part of the plan.
As we previously stated, the amount of the annual gift tax exclusion in 2016 is $14,000. Each taxpayer has this exclusion at his or her disposal. If you are married, your spouse has a $14,000 exclusion to use, and you have your own exclusion. In total, as a couple you can give $28,000 to any number of gift recipients during the calendar year tax-free.
By doing this you are transferring assets to heirs who would someday be inheriting them tax-free. The estate planning value of this is self-evident. In addition, you are steadily reducing the value of your estate for tax purposes as you give these tax-free gifts.
When you’re talking about very wealthy people, $28,000 per person, per year can seem like a relatively small amount of money to transfer tax-free. However, if you use this exclusion over an extended period of time and you give to multiple heirs, it can in fact be quite useful for many high net worth families.
To use this exclusion you don’t have to give direct cash gifts. Family limited partnerships are popular among people looking for asset protection and tax efficiency. You could use the exclusion to distribute shares in a family limited partnership tax-free on an annual basis.
Conveying assets into an irrevocable trust for the benefit of someone else can be looked upon as an act of taxable gift giving by the Internal Revenue Service. You could use the annual gift tax exclusion to fund such a trust incrementally without incurring any gift tax responsibility.
It should be noted that you do not have to use either of these exclusions to give tax-free gifts to your spouse. There is an unlimited marital deduction. This allows you to give unlimited lifetime gifts to your spouse free of the gift tax. You could also bequeath an unlimited amount of money and/or property to your spouse tax-free using this marital deduction, as long as your spouse is an American citizen.
Preserve Your Wealth
If you would like to discuss wealth preservation strategies with a licensed estate planning attorney, call us at 239-225-7911 or drop us a line through our contact page to set up a consultation.