In the U.S., we treat the estate tax and gift tax as a single tax system with unified limits and tax rates—but it is not very well understood by many people. Plus, the estate tax exemption is currently as high as it’s ever been, so many people ignore it assuming it doesn’t and never will apply to them.
However, the estate and gift tax has always been a political football, so it is a good idea to familiarize yourself with it in an election year. The Motley Fool’s recent article entitled “What Is the Estate Tax in the United States?” gives us an overview of the U.S. estate and gift tax, including what assets are included, tax rates and exemptions in 2020. As an overriding point, this blog covers federal estate and gift tax. Some states have their own estate, gift and/or inheritance tax (tax on all transfers to beneficiaries at a lower rate) which may work differently then the federal tax.
The U.S. estate tax only impacts the wealthiest households. Let’s look at why that’s the case. Americans can exempt a certain amount of assets from their taxable estate—the lifetime exemption. This amount is modified every year to keep pace with inflation and according to policy modifications. This year, the lifetime exemption is $11.58 million per person. Therefore, if you’re married, you and your spouse can collectively exclude twice this amount from taxation ($23.16 million). To say it another way, if you’re single and die in 2020 with assets worth a total of $13 million, just $1.42 million of your estate would be taxable.
However, most Americans don’t have more than $11.58 million worth of assets when they pass away. This is why the tax only impacts the wealthiest households in the country. It is estimated that less than 0.1% of all estates are taxable. Therefore, 99.9% of us don’t owe any federal estate taxes whatsoever at death. You should also be aware that the lifetime exemption includes taxable gifts as well. If you give $1 million to your children, for example, that counts toward your lifetime exemption. As a result, the amount of assets that could be excluded from estate taxes would be then decreased by this amount at your death.
You don’t have to pay any estate or gift tax until after your death, or until you’ve used up your entire lifetime exemption. However, if you give any major gifts throughout the year, you might have to file a gift tax return with the IRS to monitor your giving. There’s also an annual gift exclusion that lets you give up to $15,000 in gifts each year without touching your lifetime exemption. There are two key points to remember:
- The exclusion amount is per recipient. Therefore, you can give $15,000 to as many people as you want every year, and they don’t even need to be a relative; and
- The exclusion is per donor. This means that you and your spouse (if applicable) can give $15,000 apiece to as many people as you want. If you give $30,000 to your child to help her buy their first home and you’re married, you can consider half of the gift from each spouse.
The annual gift exclusion might be an effective way for you to reduce or even eliminate estate tax liability. The tax rate is effectively 40% on all taxable estate assets.
It is also worth noting that a lot of clients want to give away assets during their life time through annual gift exclusions because they are worried about the estate tax. However, with such a high exemption, it is often better to keep assets in your estate. This is because generally appreciable assets in your estate receive a “step-up” in basis at your death. This point is outside the scope of this blog, but see here for why keeping assets in your estate is probably a good thing. https://www.galliganmanning.com/higher-estate-tax-exemption-means-you-could-save-income-taxes-by-updating-your-estate-plan/
Finally, the following kinds of assets aren’t considered part of your taxable estate:
- Anything left to a surviving spouse, called “the unlimited marital deduction”;
- Any amount of money or property you leave to a charity;
- Gifts you’ve given that are less than the annual exclusion for the year in which they were given; and
- Some types of trust assets.
Some candidates seeks to greatly lower the estate and gift tax exemption, which may lead to many more taxable estates. If you are concerned about this tax, or are after the election, please contact our office to discuss how the estate and gift tax impacts you.
Reference: The Motley Fool (Jan. 25, 2020) “What Is the Estate Tax in the United States?”