In estate planning, a transfer refers to giving away a property interest (i.e., giving a gift). Property interests can be transferred either during your lifetime or upon your death. Whenever these transfers occur, taxes can be imposed. There are differences between lifetime transfers and testamentary transfers regarding taxes and applicable exclusions.
Federal gift and estate taxes
Although the federal and gift tax rates are the same, it is possible to transfer more assets, with lower gift and estate tax consequences, when you do so through lifetime transfers, as opposed to testamentary transfers. Why? Part of the reason is that, the money spent on estate taxes, but not gift taxes, is considered part of the estate. Therefore, those funds are taxed. However, the money used to pay gift taxes during your lifetime are not subject to either gift or estate taxes.
The benefits of the gift tax exclusion
Another benefit of lifetime transfers is that you can take advantage of the annual gift tax exclusion. This exclusion is not available with testamentary transfers. By making lifetime gifts of certain property that will appreciate or produce income, you can remove that property from your estate. Doing this can lower your estate tax consequences as to that transferred property.
What is the annual gift tax exclusion?
The annual gift tax exclusion allows all gifts that fall within the exclusion amount to be non-taxable. The amount of the annual gift tax exclusion for 2015 is $14,000, per recipient, each year. There is no limit, as long as your gifts are in the amount of $14,000 or less, to any one person, each year. Spouses can combine their gift tax exclusion amounts each year, making a joint gift of no more than $28,000 also tax free.
What is the unified tax credit?
Together, the gift tax exclusion and the estate tax exclusion are referred to as the “unified credit.” They entitle taxpayers to a lifetime exclusion of $53.4 million in 2015. This means, essentially, that your estate will be exempt from inheritance taxes up to $5.34 million. The unified credit is “portable,” which means that if you do not use the entire amount of your unified tax credit, your spouse can use the remainder of your exclusion along with his or her own.
Disadvantages of making lifetime transfers
Possibly the most important disadvantage of making gifts during your lifetime is the possibility you will lose the opportunity to acquire a stepped-up capital gains cost basis for the gifted property at your death. What does that mean? It means you own property that is valued greater than its current income tax basis. This may be because the value has increased, or it may mean that you claimed depreciation deductions on your income taxes.
If you have questions regarding lifetime or testamentary transfers, or any other estate planning needs, please contact the Schomer Law Group either online or by calling us at (310) 337-7696.