It is a satisfying feeling to come to the realization that you have been able to achieve all of your financial goals. You can breathe a sigh relief and enjoy the fruits of your labor as you provide opportunities for the people that you love. This being stated, there is a looming threat that can severely impact high net worth individuals and their families.
We have a federal estate tax in the United States, and it can take a heavy toll, because it carries a very hefty 40 percent maximum rate. Fortunately, the tax is not applied to the entirety of your estate, because there is a relatively high credit or exclusion. This is the amount that can be transferred before the estate tax would become applicable.
At the time of this writing in 2019, the federal estate tax exclusion stands at $11.4 million. There are annual adjustments to account for inflation, so the figure may change slightly next year. You do not have to use any of this exclusion to give tax-free bequests to your spouse, as long as you are married to an American citizen. There is an unlimited marital deduction that allows you to transfer any amount of money and/or property to your spouse free of taxation.
Speaking of spouses and the estate tax, since 2011, the estate tax exclusion has been portable. This means that a surviving spouse can use the exclusion that was afforded to his or her deceased spouse. Using the figures that are in place right now, a surviving spouse would have a total exclusion of $22.8 million.
You would logically consider lifetime gift giving as a way to get around the estate tax. This is what people used to do shortly after the estate tax was enacted in 1916. In 1924, a gift tax was put into place to close this window of opportunity. It was repealed in 1926, but the gift tax returned in 1932, and it has been a fact of life ever since then.
The federal gift tax is unified with the estate tax, so the exclusion is a unified exclusion. It encompasses large gifts that you give while you are living along with the estate that will be transferred after you pass away. We say “large” gifts because there is an additional estate tax exclusion. There is an annual $15,000 per person gift tax exclusion that allows you to give this much to any number of people in a calendar year tax-free.
There are some states in the union that have state-level estate taxes. Fortunately, there is no state estate tax in California. This being stated, if you own valuable property in a state with its own estate tax, it could be a applicable. We can let you know where you stand if you are in this situation.
Estate Tax Efficiency Strategies
If you are exposed to death taxes, you have to implement estate tax efficiency strategies. As we mentioned above, there is an annual gift tax exclusion that sits apart from the unified gift and estate tax exclusion. You could use this exemption to divest yourself of a considerable amount of assets over the years.
The exclusion is allotted to each individual taxpayer, so if you are married, you and your spouse could give $30,000 to any number of gift recipients in a given year free of taxation. To provide an example, let’s say that you have three married children. You could give $30,000 to each husband and each wife, so you would be transferring $180,000 tax-free every year. This can add up to a considerable amount of money over a decade or more, and you would be reducing the taxable value of your estate as you are giving these tax-free gifts.
While we are on the subject of gift giving as a way to avoid the estate tax, we should point out the fact that you can pay school tuition for others without being taxed for your generosity. This is a tuition-only exemption that does not extend to living expenses, books, fees, etc. However, you could use your $15,000 annual gift tax exclusion to provide some extra support for a student.
Family limited partnerships can facilitate asset transfers at a tax discount, and there are a number of different types of irrevocable trusts that provide estate tax efficiency. These would include generation-skipping trusts, qualified personal residence trusts, grantor retained annuity trusts, and charitable lead trusts, just to name a handful.
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We are holding a series of free seminars over the coming weeks, and we urge you to attend the session that fits into your schedule. To get all the details, visit our seminar page and follow the simple instructions to reserve your seat.
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