If you have a moderate to large estate, one of your estate planning goals should be to limit the amount of gift and estate taxes your estate owes after you are gone. Failing to plan for the impact estate taxes could have can result in the loss of a significant portion of your estate. To help you better understand, we will discuss how to limit your estate’s exposure to estate taxes.
Federal Gift and Estate Tax Basics
Every estate is potentially subject to federal gift and estate taxes. The federal gift and estate tax is basically a tax on the transfer of wealth that is collected from your estate after you are gone and during the probate process. The tax applies to all qualifying gifts (just about every gift you make will be considered a “qualifying” gift) made during a taxpayer’s lifetime as well as all estate assets owned by the taxpayer at the time of death. To illustrate how the tax works, imagine you made gifts during your lifetime totaling $5 million in value. Your estate, at the time of your death, was valued at an additional $10 million. The combined total of $15 million would be subject to federal gift and estate taxes. Historically, the federal gift and estate tax rate fluctuated on a yearly basis. The American Taxpayer Relief Act of 2012 (ATRA), however, permanently set the rate at 40 percent. Without any deductions or adjustments, your $15 million estate would owe $6 million in federal gift and estate taxes.
Tax Avoidance Strategies
No one wants to leave their estate vulnerable to gift and estate taxes; however, you must plan ahead to avoid doing just that. The good news is that there are several estate planning strategies that can help you limit your estate’s exposure to gift and estate taxes, including:
- Lifetime gifting – one of the easiest ways to limit your estate’s exposure to estate taxes is to transfer as much of your wealth as possible during your lifetime. Doing so can greatly reduce the value of your probate estate which, in turn, lowers (or eliminates) your tax burden. You must consult with an estate planning attorney, however, to make sure that your gifts are not included in your taxable estate.
- Lifetime exemption – every taxpayer is entitled to make use of the lifetime exemption to reduce the amount of gift and estate taxes owed by their estate. ATRA set the lifetime exemption amount at $5 million, to be adjusted for inflation each year. In 2018, however, President Trump signed tax legislation into law that changed the lifetime exemption amount for that year and for several years thereafter. Gift and estate taxes are only calculated on the value of your estate that exceeds the current lifetime exemption amount.
- Annual exclusion –the exclusion allows each taxpayer to make annual gifts valued at up to $15,000 (for 2019) to an unlimited number of beneficiaries without those gifts counting toward your lifetime exemption. Married couples can combine their exclusion and make gifts valued at up to $30,000. Over the course of a few years you could transfer a noticeable amount of your estate assets if you plan ahead.
- Asset protection trust – trusts have evolved to the point where there is a trust to help achieve almost any estate planning goals. There are several trusts that are designed to help protect your assets. All of those trusts begin as an irrevocable living trust. The reason for this is that the law views the assets in such a trust as belonging to the trust once they are transferred into the trust. Consequently, those assets are not included in your estate for purposes of calculating federal gift and estate taxes.
Note: When planning to avoid taxes, don’t forget that some states also impose a gift and estate tax that could impact your estate. California is not one of the states that imposes a state level tax; however, if you own assets located in another state you could be subject to paying the tax in that state.
Please download our FREE estate planning checklist. If you would like to discuss ways to protect your own estate from gift and estate taxes, contact us at the Northern California Center for Estate Planning & Elder Law by calling (916)-437-3500 or by filling out our online contact form.