When most people think about estate planning they think about making decisions regarding the distribution of their estate assets when they are gone. While that is certainly an important part of an estate plan, it shouldn’t be the only consideration when you create your estate plan. Among the other important considerations when you create an estate plan should be the impact federal gift and estate tax will have on your estate.
What Is the Federal Gift and Estate Tax?
The federal gift and estate tax is a tax that is imposed by the federal government on all qualifying gifts made by a taxpayer during his/her lifetime and all assets owned by the taxpayer at the time of death. For example, if you made gifts of assets during your lifetime valued at $4 million and you owned assets valued at $6 million at the time of your death, your estate would be subject to federal gift and estate taxes for the combined value of $10 million at a tax rate of 40 percent. Therefore, without any deductions or planning ahead for the impact of taxes on your estate, your estate would lose a shocking $4 million to federal gift and estate taxes. Any federal gift and estate taxes that are due from your estate must be paid during the probate of your estate after your death.
The Lifetime Exemption
Fortunately, every taxpayer is entitled to make use of the lifetime exemption before federal gift and estate taxes are imposed. Historically, the lifetime exemption amount fluctuated on a yearly basis; however, the American Taxpayer Relief Act of 2012 (ATRA) permanently set the lifetime exemption amount at $5 million, adjusted annually for inflation. For 2017, the lifetime exemption amount is $5.49 million. In the example used above, using the lifetime exemption would reduce your taxable estate from $10 million to $4.51 million.
The Unlimited Marital Deduction and Portability
If you are married, there are a couple of other important point about the federal gift and estate tax that you need to know. First, the unlimited marital deduction allows a taxpayer to leave an unlimited number of assets to a spouse tax-free. In other words, you could gift your entire estate to your spouse at the time of your death without incurring any federal gift and estate taxes; however, relying on the marital deduction often results in overfunding a spouse’s estate. If the value of your assets would incur the tax, shifting them to your spouse simply prolongs payment of the tax. Moreover, if your spouse owns any separate assets you have now created an even bigger tax obligation for your spouse’s estate.
Portability is a concept that was also made permanent with the passage of ATRA and refers to the ability of a surviving spouse to use any unused portion of a deceased spouse’s lifetime exemption. For example, let’s say that your spouse died, leaving behind an estate valued at $2 million and having made qualifying lifetime gifts valued at another $2 million for a total of $4 million. With a current lifetime exemption of $5.49 million, your spouse would leave $1.49 million of his/her exemption unused. That $1.49 would be “ported” over to you and be available for your use upon your death. If you were to also die during 2017 when the lifetime exemption amount is $5.49 million it would give you a total exemption amount of $6.98 million.
The Annual Exclusion
The annual exclusion is sometimes confused with the lifetime exemption. Although they are not interchangeable, there is a relationship between the two. The annual exclusion allows you to make yearly gifts valued at up to $14,000 to an unlimited number of beneficiaries tax-free. Gifts made using the annual exclusion do not count toward your lifetime exemption limit. If you are married, you and your spouse may also use the gift-splitting option to make combined gifts valued at up to $28,000.
If you have additional questions or concerns related to the federal gift and estate tax, contact the experienced Massachusetts estate planning attorneys at DeBruyckere Law Offices by calling (603) 894-4141 or (978) 969-0331 to schedule an appointment.