It is certainly satisfying to achieve your goals, but if you have been quite successful from a financial standpoint, you have to preserve your legacy. There is a federal estate tax in place, and it can take a heavy toll, because it carries a hefty 40 percent maximum rate.
The estate tax is only a factor for wealthy individuals because there is a relatively high credit or exclusion. This is the amount that can be transferred before the estate tax would become applicable. This figure is adjusted annually to account for inflation, but at the time of this writing in 2019, it is $11.4 million.
This is a per person exclusion, so if you are married, you and your spouse would have a combined $22.8 million exclusion. While we are on the subject of spouses and the estate tax, you should be aware of the fact that this exclusion is portable. In an estate planning context, the term “portability” is used to describe the ability of a surviving spouse utilize the exclusion that was allotted to his or her deceased spouse.
When you hear about the existence of the federal estate tax, you may come up with a logical idea to get around it. At some point in time, you could simply give gifts to your loved ones to avoid the death tax, right? This used to be possible when the estate tax was first enacted in 1916, and a lot of people used this loophole back then. As a response, a federal gift tax was put into place a few years later. It was briefly repealed, but it came back for good in 1932.
However, there is an annual gift tax exclusion that opens the door slightly. It allows you to give limited gifts to others every year free of the gift tax. During the current calendar year, the amount of the annual gift tax exclusion is $15,000 per person. If you are going to be exposed to the federal estate tax, you can use this exclusion to give tax-free gifts to reduce the value of your estate.
Though it is a rather limited number, it can add up if you and your spouse give gifts consistently over a number of years. To provide an example, let’s say that you have three married children. You have a $15,000 per person exclusion to utilize every year, and your spouse has one as well. As a couple, you could give $30,000 annually to each husband and each wife, which is a total $60,000 per family. We are talking about three different families, so you can divest yourself of $180,000 per year tax-free. If you do this for 20 years, you are looking at $3.6 million in tax-free asset transfers.
When it comes to the $11.4 million lifetime exclusion, this is a unified exclusion. It applies to gifts that you give that exceed $15,000 per person within a year along with the estate that will be transferred after you pass away.
If you are going to be exposed to the federal estate tax, you must take steps to gain estate tax efficiency. There are different types of trusts used in the field of estate planning. Some of them are revocable, and some of them are irrevocable. If you were to establish a revocable trust, you would retain incidents of ownership, because you would have the power to dissolve the trust and take back direct personal possession of the assets that have been conveyed into it. Since you retain incidents of ownership, assets in this type of trust would be part of your estate for tax purposes, so there would be no benefit from a tax efficiency perspective.
On the other hand, assets that you convey into an irrevocable trust would not be part of your estate, because you have no access to the assets once you convey them into the trust. Irrevocable trusts that are used for estate tax efficiency purposes include grantor retained annuity trusts, charitable lead trusts, qualified personal residence trusts, and generation-skipping trusts, just to name a handful.
Attend a Free Seminar!
Our firm is offering a fantastic opportunity for locals to gain a great deal of important estate planning knowledge. We are conducting a series of seminars over the coming weeks, and we urge you to attend the session that fits into your schedule. There is no charge, but space is limited, so we do ask that you reserve your seat in advance. You can do just that if you take a moment to visit the seminar page on this website.