While the focus of your estate plan may be on the manner in which your estate assets are distributed after you pass away, you also need to devote sufficient thought to protecting assets while you are alive and at the time of your death to maximize the assets available for distribution. That requires you to incorporate tax avoidance strategies into your estate plan when appropriate. Toward that end, the attorneys at Eghrari Law Firm explain how to incorporate the annual exclusion into your estate plan.
Federal Gift and Estate Tax Basics
The federal gift and estate tax effectively acts as 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 federal gift and estate taxation. 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. Consequently, without any deductions or adjustments to the value of your estate, you could lose 40 percent of that value to Uncle Same in the form of federal gift and estate taxes.
How Is the Federal 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 life worth a combined total of $7 million. At the time of your death, you owned assets with a total value of $10 million. The combined total of $17 million would potentially be subject to federal gift and estate taxes. Without any further adjustments, your estate would lose a staggering $6.8 million to federal gift and estate taxes!
How Does the Lifetime Exemption Work?
Fortunately, each taxpayer is entitled to make use of the lifetime exemption to reduce the amount of gift and estate taxes owed by their estate. ATRA set the lifetime exemption amount at $5 million, to be adjusted for inflation each year. President Trump, however, signed tax legislation into law that changed the lifetime exemption amount for 2018 and for several years to come. Under the new law, the exemption amounts increased to $13.61 million for individuals and $27.22 million for married couples for 2024. These exemption amounts are scheduled to increase with inflation each year until 2025. On January 1, 2026, the exemption amounts are scheduled to revert to 2017 levels, adjusted for inflation. With the lifetime exemption, a $17 million estate would only be taxed on the amount over the lifetime exemption amount, or $3.39 million for 2024. While that is great news, an estate would still lose over $1.3 million of its value to estate taxes.
How Can the Annual Exclusion Help?
Leveraging the lifetime exemption can effectively minimize your estate’s susceptibility to federal gift and estate taxes. Yet, integrating additional tax avoidance strategies into your estate plan well in advance can further decrease your overall tax liability. One such strategy is utilizing the annual exclusion, which allows you to transfer a substantial portion of your wealth without incurring taxes.
Using the exclusion, an individual can make yearly gifts valued at up to $18,000 (for 2024) to an unlimited number of beneficiaries without those gifts counting toward their lifetime exemption limit. A married couple can double the amount, meaning they can give up to $36,000 per beneficiary each year. Assuming you are married in the above example and have four children. If you and your spouse made the maximum gifts to your two children and 4 grandchildren each year for 10 years, you could transfer $216,000 a year (starting in 2024) tax-free for a total tax-free wealth transfer of $2.16 million at the end of the 10-year period. You could save your estate $864,000 in taxes, meaning your loved ones will receive almost an additional million dollars from your estate.
Do You Have Additional Questions about the Annual Exclusion?
For more information, please join us for a FREE estate planning seminar. If you have additional questions about how to incorporate the annual exclusion into your estate plan, contact the Long Island estate planning attorneys at Eghrari Law Firm by calling us at 631-265-0599 to schedule your appointment.
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