For many people, a successful estate plan needs to limit exposure to federal and/or state gift and estate taxes. Failing to incorporate tax avoidance strategies into your estate plan could cost your estate (and your beneficiaries) a substantial amount of money. With that in mind, the Los Angeles estate planning attorneys at Schomer Law Group, APC explain how you can benefit from incorporating the annual exclusion into your estate plan.
Understanding Federal Gift and Estate Taxes
The federal gift and estate tax is essentially 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 the tax. 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. That means that absent any deductions or adjustments to your estate’s value, you could lose 40 percent of that value to federal gift and estate taxes.
Calculating the Federal Gift and Estate Tax
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!
The Lifetime Exemption
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 that changed the lifetime exemption amount for 2018 and several years to come. Under the new law, the exemption amount for an individual taxpayer increased to $12.92 million for 2023. 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. That $17 million estate would only be taxed on the amount over the lifetime exemption amount, or $4.08 million for 2022. That still means that the estate would lose more than $1.6 million in estate taxes.
The Annual Exclusion
Using the lifetime exemption significantly reduces your estate’s exposure to federal gift and estate taxes; however, there are additional tax avoidance strategies that can reduce your tax debt even more if incorporated into your estate plan far enough ahead of time. For instance, the annual exclusion, also referred to as the yearly exclusion, can help you transfer a sizable portion of your wealth tax-free. Using the exclusion, an individual can make yearly gifts valued at up to $17,000 (as of 2023) 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 gift up to $34,000 per beneficiary each year. In the above example, assume you are married, and you and your spouse make the maximum gifts to your four children each year for 10 years. You could transfer $136,000 a year tax-free for a total tax-free wealth transfer of $1.36 million at the end of the 10-year period. You could save your estate $544,000 in taxes, meaning your beneficiaries will gain an additional half a million dollars.
Contact Los Angeles Estate Planning Attorneys
For more information, please join us for an upcoming FREE seminar. If you have additional questions or concerns about incorporating the annual exclusion into your estate plan, contact the experienced Los Angeles estate planning attorneys at Schomer Law Group APCby calling (310) 337-7696 to schedule an appointment.
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