The federal estate tax can have a significant impact on your legacy if it will be levied on your estate, because it carries a 40 percent top rate. However, it is only a factor for people that have accumulated a very significant store of wealth.
There is an estate tax exclusion that is higher than it has ever been right now. It stands at $11.7 million, and it was established when the Tax Cuts and Jobs Act was enacted in 2017. Prior to its enactment, the exclusion was $5.49 million.
If the value of your estate is that exceeds the exclusion, the tax will not be a factor for you.
Congress enacted an estate tax in 1918, and there was no gift tax at that time. As you would expect, anyone that was exposed to the tax would give their children their inheritances in advance to avoid taxation.
This was certainly not the spirit of the imposition of the estate tax in the first place, so a gift tax was enacted in 1924. It only lasted for two years before it was repealed, but in 1932, the gift tax was reenacted.
We have had a gift tax since then, so you cannot give all of your assets to your loved ones right before you pass away to get around the tax. The multimillion dollar exclusion applies to large lifetime gifts and your estate, but the “large” qualifier is key.
Annual Gift Tax Exclusion
In addition to the $11.7 million exclusion that applies to your estate and lifetime gifts, there is an additional annual per person gift tax exclusion.
The first $15,000 that you give to any number of people in a given year is not subject to taxation. You do not have to use any of your unified exclusion to give these tax-free gifts.
To be clear, you can transfer an unlimited amount of money tax-free each year as long as you do not give more than $15,000 to a particular person. This exclusion is allotted to each taxpayer, so a married couple could give $30,000 to any number of people each year.
If you are exposed to the estate tax, you can use this exclusion to transfer a significant amount of money in a tax-free manner. For example, if you have four married children, you and your spouse could give $30,000 to each partner every year.
That would amount to $240,000 in annual tax-free transfers, and this would add up over time. In addition to direct gift giving, this annual exclusion is used to fund certain types of trusts, including irrevocable life insurance trusts.
The tax-free gifts to the trust can be used to pay insurance premiums, and the proceeds can ultimately be used to pay the estate tax.
Medical Expenses and Tuition
There are two other gift tax exclusions that can be utilized. You can use the educational exclusion to pay school tuition for students tax-free. This is a tuition-only exclusion, and you have to pay the institution directly.
Of course, you can use your annual exclusion to provide extra money for books, fees, and living expenses.
You can also pay medical bills for others without being taxed, and this extends to the payment of health insurance premiums.
State-Level Estate and Gift Taxes
There are 12 states with state-level estate taxes, and there is an estate tax in the District of Columbia. We are fortunate as Ohioans because we do not have an estate tax, but if you own property in a state with such a tax, it would apply to your estate.
If you are in this position, you should check the laws because the exclusions are much lower than the federal exclusion in some states. For example, the exclusions in Massachusetts and Oregon are just $1 million.
It is possible to give lifetime gifts to avoid estate taxes in almost all of these states because there is no gift tax. Connecticut is the only state in the union with a gift tax.
Take Action Today
Today is the day for action if you are going through life without a plan, whether you are concerned about taxation or not. You can schedule a consultation at our Cincinnati estate planning office if you call us at 513-721-1513.
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