Inheritance tax is a constant concern I hear from clients. There is so much misinformation regarding what is taxed and what is not. This blog is designed to help clarify some myths regarding gift taxation during lifetime and at death.
The Federal estate tax exemption is currently $11,700,000.00 per person. This means that anyone who dies in the year 2021 can leave $11.7 million dollars in inheritance with no taxes being owed. A married couple can combine their exemption through what is called ‘portability’ resulting in an exclusion of $23,400,000.00. Portability works like this, if an individual dies and leaves any of the estate tax exemption unused, a surviving spouse will be able to add the unused exemption amount to their own exemption amount. However, to make use of the unused exemption, the estate must prepare and file a federal estate tax return at the death of the first spouse.
Where people tend to get confused is with the annual gift tax exclusion. In 2021 the annual limit for gifting is $15,000.00, however, this limit does not necessarily mean that gifts over $15,000.00 are subject to taxation. What this means is that gifts over $15,000.00 are subject to reporting to the IRS through a Gift Tax Return.
The IRS laws for lifetime gifting limits are aligned with the limits discussed above for inheritance tax. If someone makes a large gift during their lifetime, that gift amount will be subtracted from their gift limit at death. For example, if Marcel wishes to gift $50,000.00 to his daughter during his lifetime, he can do this without paying any taxes. When Marcel files his taxes for that year he must disclose the gift, which will result in an offset to his estate tax exclusion. Therefore, at his death his estate tax exclusion would be $11,200,000.00 ($11,700,000 - $50,000).
This limit is per recipient. Therefore, if Marcel decided he wanted to gift $15,000 to each of his 3 grandchildren he can do that without any impact to his estate tax exemption. Further, if Marcel makes a gift directly to a qualifying educational organization for tuition or to an institution that provided medical care for the recipient, there is no limit to the gift, and it will not offset Marcel’s estate tax exclusion.
For the majority of people, the current laws surrounding gift and inheritance tax means they will not need to worry about special planning. However, for those few who do fall into the category of needing to plan to limit taxation at death, there are options available. The most common planning tool involves using special trusts and maximizing the annual gift tax exclusion. This can ensure the transfer of some funds during lifetime while still utilizing the estate tax exclusion to its fullest. As with all taxes, the amount of taxes charged will depend on the amount of money that is subject to taxation. The current maximum tax bracket for inheritance tax is 40%.
It is important to remember that these laws change frequently and with each new administration comes new methods and limits for taxes. You should always consult with a tax professional before making any large gifts.