By Barry Zimmer on March 21st, 2019 in Estate Planning
There is a federal estate tax in the United States that is a looming threat for individuals that have been extremely successful from a financial standpoint. The reason why it is only a factor for people with significant financial resources is because there is a relatively robust exclusion that stands at $11.4 million in 2019. Only the portion of your estate that exceeds this amount would be subject to the death tax and its 40% top rate.
It is applicable on transfers to anyone, regardless of the relationships that you have with the transferee, with one exception. If you are legally married to a United States citizen, you can transfer unlimited assets to your spouse without incurring any estate tax liability.
We should also point out the fact that a surviving spouse could use the exclusion that was allotted to his or her deceased spouse. This is called “portability,” and the federal exclusion has been portable since 2011.
There are some states in the union have state-level estate taxes, and the exclusions are typically much lower than the federal exclusion. As a result, a resident of one of these states that is exempt on the federal level could face state-level exposure. There was an estate tax in Ohio where we practice law, but it was repealed at the beginning of 2013.
Federal Gift Tax
When you hear about the existence of the federal estate tax, it would be logical to consider lifetime gift giving as a way to get around it. The estate tax was originally enacted in 1916, and at that time, people that were exposed to it did give lifetime gifts to sidestep the tax.
In 1924, a gift tax was installed to close this loophole. It was repealed two years later, but it came back for good in 1934. The gift tax and the estate tax are unified under the tax code, so the $11.4 million exclusion that we have this year is a unified lifetime exclusion. This exclusion applies to large gifts that you give along with the estate that will be transferred to your heirs.
To explain through the utilization of a simple example, if you give $11.4 million in potentially taxable gifts while you are living, they can all be given tax-free because of the exclusion. However, there would be no cushion left to apply to your estate, so all of it would be subject to taxation.
Additional Gift Tax Exclusions
We made a point of using the term “large gifts” above, because this distinction is quite relevant. In addition to the unified lifetime gift and estate tax exclusion, there is also an annual gift tax exemption. This allows you to give as much as $15,000 to any number of gift recipients within a calendar year free of taxation.
The existence of this exclusion does provide some avenues that lead to estate tax efficiency. It can be used in conjunction with a family limited partnership to tax efficient transfers. It can also be utilized to fund certain types of trusts.
There is another very straightforward way to use the annual gift tax exclusion to transfer assets that may otherwise be exposed to the estate tax. If you are married, you and your spouse can combine your respective exclusions to give up to $30,000 to any number of gift recipients annually tax-free.
Let’s say that you have three married children. As a couple, you could give $30,000 to each husband and each wife. This would allow you to transfer a total of $180,000 annually in a tax-free manner, and you would be steadily reducing the taxable value of your estate.
The tax code allows for two other types of tax-free gift giving. If you want to pay medical bills for others, including health insurance, you can do so without incurring any gift tax liability.
There is also an educational exemption that you can use to pay school tuition for others in a tax exempt manner. This is a tuition-only exclusion, and the payments must be made to the institution directly. In spite of this restriction, you could use the $15,000 annual gift tax exclusion to provide additional support for books, fees, and living expenses.
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