Estate planning involves arranging for gifts to be given after you die. If you do arrange for assets to be transferred to your loved ones after you die, these transfers may be subject to the federal estate tax. This raises a logical question: can you give tax-free gifts while you are living and avoid the estate tax?
Federal Gift Tax
The estate tax was enacted in 1916. Shortly after this, people who were exposed to the tax started giving gifts while they were living to gain tax efficiency. To close this loophole the government instituted a gift tax.
These days the gift tax is still in place, and it is unified with the federal estate tax. In 2014 there is a $5.34 million federal gift/estate tax exclusion. If you give tax-free gifts while you are still alive using this exclusion, the amount of the exclusion that will be left to apply to your estate is being reduced.
As a result, giving gifts while you are living using your unified lifetime exclusion is not going to provide transfer tax efficiency. There is really no difference between giving gifts while you are living and arranging for the transfer of assets after you die from a tax perspective given the unification of the gift and estate taxes.
Annual Gift Tax Exclusion
All is not lost when it comes to giving tax-free gifts. There is another exclusion that can be utilized in addition to the unified lifetime gift and estate tax exclusion.
We have an annual per person gift tax exclusion in the United States. This exclusion sits apart from the unified lifetime exclusion. It allows you to give tax-free gifts to any number of others equaling as much as $14,000 per person, per year.
Taking advantage of this annual exclusion is a great way to give tax-free gifts to your children as you simultaneously gain long-term tax efficiency.
When you use this annual gift tax exclusion to give tax-free gifts to your children, you are transferring assets to heirs who would otherwise be inheriting them tax-free. In addition to this, you are steadily reducing the value of your estate, and in turn you are mitigating your future estate tax exposure.
A significant amount of money could be transferred to your children if you use this exclusion over an extended period of time. Some people give direct tax-free gifts, and this is a possibility. It is also possible to use this annual gift tax exclusion to distribute shares in family limited partnerships.
In addition, an irrevocable trust could be funded on an incremental basis free of taxation through the utilization of the annual gift tax exclusion.
If you are interested in learning more about tax-free gift giving, contact our firm to schedule a free wealth preservation consultation.
Mr. Kraft assists clients primarily in the areas of estate planning and administration, Medicaid planning, federal and state taxation, real estate and corporate law, bringing the added perspective of an accounting background to his work.