Before we address the question that serves as the title of this blog post, we should explain some basic facts about the estate tax. First, it is important to note that there are some states in the union that have state-level estate taxes. Here in California, there is no state estate tax, but of course we are subject to the federal tax.
This tax carries a 40% maximum rate, so it can significantly erode your legacy if you are exposed and you take no action to mitigate the damage. The good news is that there is an estate tax credit or exclusion that allows you to transfer a certain amount tax-free before the death tax would be imposed.
At the time of this writing in 2019, the exclusion is $11.4 million. There are annual adjustments to account for inflation, so you may see a somewhat higher figure next year. And of course, the entire structure can be altered via legislative mandate.
There is an unlimited marital deduction, so you can leave any amount of money to your spouse tax-free as long as you are American citizens. The estate tax exclusion is portable, so a surviving spouse could use the exclusion that his or her deceased spouse was entitled to, and this was not always the case.
Federal Gift Tax
The estate tax was enacted in 1916, and shortly after that, people did give gifts in a tax-free manner to avoid the estate tax. In 1924, a gift tax was put into place to close this window of opportunity, but it was promptly repealed in 1926. It was reenacted in 1932, and the gift tax has been a fact of life ever since then.
This tax is unified with the estate tax, so the $11.4 million exclusion that we have this year is a unified exclusion. It applies to your estate and the gift that you give to others while you are living.
In addition to this exclusion, there is a $15,000 per person, per year gift tax exclusion. You can give this amount to any number of people every year free of taxation. The $15,000 figure is accurate for 2019, but it is also adjusted periodically.
If you are exposed to the estate tax, this annual exclusion could be part of a tax efficiency strategy.
You can reduce the value of your estate significantly while you are transferring assets tax-free if you give gifts on a consistent basis. Direct gift giving is definitely an option, but you can also use this exclusion to fund certain types of trusts, and it can be useful if you have a family limited partnership.
There are a couple of other tax exclusions that allow you to assist others without giving direct cash gifts. Under the tax code, you are allowed to pay school tuition for students in a tax-free manner. It is a tuition-only exclusion that does not apply to living expenses, books, fees, etc. However, you could use your $15,000 annual exclusion to provide additional support.
The other gift tax exclusion allows you to pay medical bills for other people without incurring any gift tax exposure. This extends to the payment of health insurance premiums.
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