When creating a comprehensive estate plan that works as intended it is crucial to consider the impact federal gift and estate taxes may have on the estate you leave behind. Understanding how federal gift and estate taxes work is crucial to achieving that goal. The federal gift and estate tax rules are complex by nature, making it important to consult with a knowledgeable estate planning attorney when trying to avoid incurring the tax; however, it also helps to learn some of the basics about federal gift and estate taxes so you can better understand how they could dramatically impact your estate after you are gone. With that in mind, a Los Angeles tax planning attorney at Schomer Law Group, APC explains what you need to know about the federal gift and estate tax.
What Is the Federal Gift and Estate Tax?
Imposed and collected at the time of a taxpayer’s death, 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 are subject to the tax. Historically, the estate tax rate fluctuated from year to year; however, with the passage of the American Taxpayer Relief Act of 2012 (ATRA) the tax rate was permanently set at 40 percent. Before taking into accounting for any credits, deductions, or adjustments to the value of your estate, your entire estate value could be reduced by 40 percent because of the tax. That means you would be passing down 40 percent less than you anticipated to loved ones.
How Is the Federal Gift and Estate Tax Work in Practice?
Determining an estate’s federal gift and estate tax obligation is accomplished by adding the value of all qualifying gifts made during your lifetime to the value of all estate assets owned at the time of death. Imagine, for example, that you made gifts during your lifetime worth a combined total of $2 million and you owned assets valued at $21 million at the time of your death. The combined total of $23 million would potentially be subject to federal gift and estate taxes. Before any additional considerations, your estate would owe $9.2 million in federal gift and estate taxes – meaning that is $9.2 million that would go to Uncle Sam instead of your designated beneficiaries.
The Good News – Every Taxpayer Is Entitled to a Lifetime Exemption
Every taxpayer is entitled to make use of the lifetime exemption before calculating federal gift and estate taxes. Think of this as a deduction from the total value of your taxable estate. Historically, the lifetime exemption limit also fluctuated on a regular basis until the passage of ATRA. ATRA set the lifetime exemption limit at $5 million, to be adjusted annually for inflation. Legislation passed in 2017, however, changed the lifetime exemption amount for 2018 and for several years after that. For 2022, the exemption amount increased to $12.06 million for individuals and $24.12 million for married couples. These exemption amounts are scheduled to increase with inflation each year through 2025. In 2026, the exemption amounts are scheduled to revert to the 2017 levels, adjusted for inflation. For 2022, your $21 million estate would be reduced to a taxable estate of $8.94 million after factoring in the lifetime exemption, changing your tax liability from $9.2 million to just over $3.5 million.
How Can My Estate Avoid Federal Gift and Estate Taxes?
There are numerous tax avoidance tools and strategies that can be incorporated into your estate plan to help reduce your estate’s exposure to federal gift and estate taxes. Leaving your entire estate to a spouse using the “unlimited marital deduction” prevents your estate from incurring federal gift and estate taxes; however, relying exclusively on the deduction often over-funds your spouse’s estate, making it a less than ideal strategy. One of the many tools you may use that can help your estate avoid federal gift and estate taxes involves incorporating the annual exclusion into your estate plan. The exclusion allows you to make gifts of up to $16,000 (as of 2022) to an unlimited number of beneficiaries each year tax-free. Gifts made using the annual exclusion do not count toward your lifetime exemption. Your unique needs and circumstances will be evaluated by your estate planning attorney to decide what additional tax avoidance tools and strategies are best suited for your estate plan.
Contact a Los Angeles Tax Planning Attorney
For more information, please join us for an upcoming FREE seminar. If you have additional questions or concerns about how to incorporate tax planning into your estate plan to avoid paying federal gift and estate taxes, contact the experienced Los Angeles tax planning attorneys at Schomer Law Group APCby calling (310) 337-7696 to schedule an appointment.