Creating a comprehensive, and successful, estate plan requires you to consider much more than simply the division of your estate assets when you are gone. Protecting those assets up to the point when they are passed down to loved ones, for example, should be a primary estate planning objective in every estate plan. That requires you to consider the impact federal gift and estate taxes might have on your estate at the time of your death. Failing to include tax avoidance strategies in your estate plan could result in the loss of a significant portion of your estate’s value to a gift and estate tax bill.
What Is the Federal Gift and Estate Tax?
The federal gift and estate tax is essentially a tax on the transfer of wealth. Both transfers made during a taxpayer’s lifetime in the form of a gift and transfers made at the time of death in the form of an inheritance are subject to the tax. Historically, the estate tax rate fluctuated on a yearly basis; however, with the passage of the American Taxpayer Relief Act of 2012 (ATRA) the tax rate was permanently set at 40 percent. That means that absent any deductions or adjustments to your estate’s value, you could lose 40 percent of that value to federal gift and estate taxes.
How Is the Gift and Estate Tax Calculated?
The federal gift and estate tax is levied on the combined value of all qualifying gifts made during your lifetime and the value of all estate assets owned at the time of your death. For example, imagine that you made gifts to children and other loved ones during your lifetime worth a combined total of $3 million. At the time of your death, you owned assets with a total value of $5 million. The combined total of $8 million would potentially be subject to federal gift and estate taxes. Without any further adjustments, your estate would lose $3.2 million to Uncle Sam!
The Lifetime Exemption
Fortunately, every taxpayer is entitled to make use of the lifetime exemption. The lifetime exemption amount was also historically subject to change prior to the passage of ATRA. ATRA, however, set the exemption at $5 million, adjusted annually for inflation. For 2017, the lifetime exemption limit is $5.49 million. This means your estate will not incur a federal gift and estate tax obligation unless the combined value of your lifetime gifts and estate assets at the time of your death exceed the exemption limit. In our example, the combined value of your estate assets and gifts is $8 million. After deducting the current lifetime exemption limit of $5.49 million you are left with a taxable estate of $2.51 million. Your federal gift and estate tax obligation would decrease from $3.2 million to $1,004,000 after deducting the lifetime exemption.
Tax Avoidance Strategies – The Annual Exclusion
As you can see, using the lifetime exemption significantly reduces your estate’s exposure to federal gift and estate taxes; however, there are additional tax avoidance strategies that can reduce your tax debt even more if incorporated into your estate plan far enough ahead of time. The annual exclusion, for example, can help you transfer a sizable portion of your wealth tax-free. Using the exclusion, you can make yearly gifts valued at up to $14,000 to an unlimited number of beneficiaries. The gifts are not taxed nor do they count toward your lifetime exemption limit. In the above example, assume you made the maximum gifts to your four children each year for 15 year. You could transfer $56,000 a year tax-free for a total tax-free wealth transfer of $840,000 at the end of the 15-year period. Your estate would save $336,000 in federal gift and estate taxes as a result of your use of the annual exclusion.
For more information, please download our FREE estate planning worksheet. If you have additional questions or concerns regarding the federal gift and estate tax, contact the experienced Florida estate planning attorneys at Kulas Law Group by calling (772) 398-0720 to schedule an appointment.