There are not many downsides to wealth accumulation, but there is an exception when it comes to estate planning matters. The federal estate tax can be a factor if the value of your estate exceeds the credit or exclusion, and it carries a hefty 40 percent top rate.
2021 Federal Estate Tax Exclusion
In 2010, the estate tax was completely repealed because of a provision in the Bush era tax cuts, but it was scheduled to return in 2011.
At the end of that year, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, and it established a $5 million exclusion for the following year. This figure was retained adjusted for inflation through 2017 when it was $5.49 million.
The Tax Cuts and Jobs Act was enacted in December of 2017, and it doubled the exclusion with another inflation adjustment. It was $11.18 million that year, and it has risen to $11.7 million this year.
This provision is going to expire at the beginning of 2026, and at that time, the exclusion will go down to $5.49 million again if there are no changes in the meantime.
There is an unlimited marital deduction, so unlimited assets can be transferred between spouses tax-free as long as the individuals are American citizens. The aforementioned measure that was passed in 2011 made the exclusion portable, and portability has been retained since then.
In this context, the term is used to describe the ability of a surviving spouse to add their deceased spouse’s exclusion to their own exclusion.
Federal Gift Tax
The obvious response to the estate tax would be lifetime gift giving, and this was done shortly after the estate tax was enacted in 1918. A gift tax was put into place six years later, it was repealed in 1926, and it was reenacted in 1932.
It is unified with the estate tax, so the multimillion-dollar exclusion that we have explained applies to lifetime gifts. As a result, you cannot simply give gifts to completely avoid the estate tax, but there is some latitude in this regard.
Additional Gift Tax Exclusions
There is an educational exclusion that you can use to pay school tuition for others tax-free. It does not extend to books and fees or living expenses, and you have to pay the institution directly.
If you want to pay health care insurance premiums and/or medical bills for someone else, the payments would not be looked upon as a taxable gift by the Internal Revenue Service.
The most significant gift tax exclusion that sits apart from the unified exclusion is the annual $15,000 per person exclusion. Each taxpayer can give this amount to an unlimited number of people each calendar year free of the gift tax.
Since this is a per person exclusion, a married couple would be able to combine forces to give $30,000 to any number of gift recipients in a year. With regard to the education exclusion, the annual exclusion can be used to cover the additional expenses.
The sustained utilization of this exclusion over a number of years can facilitate the transfer of a significant amount of money tax-free as the value of your estate is reduced.
Direct gift giving is not the only option. The annual gift tax exclusion can be used to fund certain types of trusts, including life insurance trusts, and infusions can be used to pay policy premiums.
When the payout is received, the proceeds can be used to pay all or some of the estate taxes. This is one type of trust that can be part of an estate tax efficiency strategy, but there are a number of others. We will share the specifics in a future post.
New York Estate Tax and the Three-Year Clawback
We have a state-level estate tax in New York with $5.93 million exclusion this year. There is no gift tax per se, but there is a three-year clawback provision. Large gifts that you give within three years of your passing are considered to be part of your estate for tax purposes.
With proper planning undertaken with an experienced estate planning attorney you can avoid unintended mistakes due to this NYS three-year clawback and minimize your estate taxes.
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We are ready to spring into action if you would like to work with an estate planning lawyer to put a plan in place. You can send us a message to request a consultation appointment, and we can be reached by phone at 332-456-0500.