There are federal transfer taxes that you must contend with if you have been particularly successful throughout your life. You may be aware of the fact that there is a federal estate tax. What you may not be aware of is that there is also a federal gift tax, and it is unified with the federal estate tax.
Unified Gift/Estate Tax
The amount of the lifetime unified gift and estate tax exclusion is $5.45 million in 2016. This is the amount that you can transfer to others while you are alive or after you pass away free of transfer taxes.
The maximum rate of the gift and estate tax is 40 percent. Once you transfer assets that exceed this amount, the transfer taxes are a factor.
Clearly, a tax that reduces the amount of your legacy by this percentage is something to take seriously. There are tax efficiency strategies that can be utilized to mitigate your exposure. One of them would involve utilization of the annual gift tax exclusion.
Annual Gift Tax Exclusion
The lifetime unified gift/estate tax exclusion is not the only exclusion that can be utilized when you are arranging for tax efficient asset transfers. We also have an annual per person gift tax exclusion.
The amount of this exclusion is periodically increased to account for inflation. For 2016, the annual gift tax exclusion amount is $14,000 per person.
You are allowed to give gifts totaling as much as $14,000 to any number of people within a calendar year free of the gift tax.
We must emphasize the fact that these divestitures would not be deducted from your available unified $5.45 million exclusion. The annual gift tax exclusion is something that exists completely separate from the unified transfer tax exclusion.
Because this is a per person exclusion, you could engage in something called “gift splitting” if you are married. Your spouse is entitled to a $14,000 annual gift tax exclusion, and you are entitled to your own annual gift tax exclusion. If you combine the two, you can give $28,000 to any number of people within a calendar year free of the gift tax.
This can enable some significant tax-free asset transfers over an extended period of time. Let’s say that you have three married children. You could give $28,000 to each husband and each wife. That equates to a transfer of $56,000 multiplied by three ($168,000) each year.
If you do this over a number of years (or perhaps a couple of decades) it can have a significant impact. The assets get transferred free of taxation, and the remainder of your taxable estate is being reduced.
When you envision gift giving you probably think about handing someone a check. You can in fact use the annual gift tax exclusion to give direct cash gifts to people in a tax-free manner.
However, in the field of estate planning the annual gift tax exclusion is used to set aside assets for the benefit of others in different ways. For example, family limited partnerships are very popular among high net worth individuals. They provide asset protection, and they can also provide tax efficiency.
As the name implies, these partnerships are comprised of people who are members of the same family. If you are the person creating the partnership you would be the general partner. You could make people that you bring into the partnership limited partners.
It would be possible to use this annual gift tax exclusion to give gifts of shares in the partnership each year up to the amount of the exclusion.
This approach can also be taken to fund certain types of irrevocable trusts on an incremental basis to gain tax efficiency.
Additional Gift Tax Exemptions
This post is largely centered on the annual gift tax exclusion that sits at $14,000 at the present time. However, while we are on the subject, we would like to touch upon two different gift tax exemptions that can be used when you are looking for tax efficiency strategies.
You are allowed to pay school tuition for students without incurring any gift tax liability. There is no limit to the number of students that you can assist, and these educational gifts can total any amount of money.
However, you must make the payments directly to the institutions. You can’t give the money to the student and hope that he or she pays the tuition.
In addition to this, you may not pay for living expenses, books, and fees tax-free. This is a tuition only exemption.
There is also an unlimited medical gift tax exemption. You can pay health care expenses for someone else as a gift free of the gift tax. You can do this for any number of people, and there is no limit to the total expenditures that are allowable.
Once again, you must pay the medical service provider directly.
It is worthwhile to mention the fact that this exemption extends to the purchase of health insurance for the benefit of others.
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