Creating a successful estate plan requires you to consider a number of important factors, including your goals and objectives, your current and future assets, and the impact federal gift and estate taxes will have on your estate. While most people spend a considerable amount of time contemplating the first two factors, people often fail to spend enough time thinking about the third factor. Sometimes people fail to take gift and estate taxes into account because they are unaware of the impact the tax can have on their estate while others don’t focus on the tax because they (mistakenly) think it won’t affect them. Knowing how the federal gift and estate tax can diminish your estate value, however, is crucial if you wish to create a successful estate plan that allows you to maximize the value of the estate you pass down to your loved ones.
What Is the Federal Gift and Estate Tax?
As you probably already know, almost everything in the United States is potentially subject to taxation by the local, state, and/or federal government. The federal gift and estate tax is essentially a tax on the transfer of wealth. Because wealthy families traditionally found ways to keep the wealth in the family without subjecting it to taxation, the gift and estate tax evolved as a way to ensure that all transfers of wealth were taxed at the time of death.
How Is the Gift and Estate Tax Computed?
The federal gift and estate tax is potentially levied on the value of all qualifying gifts made during your lifetime as well as on the value of your estate assets at the time of your death. For all intents and purposes, assume that all gifts made during your lifetime qualify unless your estate planning attorney advises you that a gift qualifies for an exception or exclusion. By way of illustration, assume that you made gifts to friends and family during your lifetime valued at $2 million and that your estate assets were valued at $7 million at the time of your death. You would therefore have an estate valued at $9 million that is subject to the federal gift and estate tax.
What Is the Gift and Estate Tax Rate?
Historically, the federal gift and estate tax rate fluctuated on a regular basis. In 2012, however, the American Taxpayer Relief Act (ATRA) was passed by Congress, permanently setting the gift and estate tax rate at 40 percent. Imagine if your entire $9 million estate was subject to a 40 percent tax rate! You would lose $3.6 million to taxes! This is precisely how the federal gift and estate tax can diminish the value of your estate. Fortunately, however, there are ways to reduce the impact of the tax.
The Lifetime Exemption
Every taxpayer is entitled to exempt gifts and/or assets valued at up to the lifetime exemption limit. Like the tax rate, the lifetime exemption was once subject to change. Also like the tax rate, however, ATRA permanently set the lifetime exemption amount at $5 million, allowing for a yearly increase for inflation. For 2016, the lifetime exemption limit is set at $5.45 million. Therefore, your $9 million estate is reduced to a taxable estate valued at $3.55 million. Of course, that still means your estate would lose $1.42 million to federal gift and estate taxes.
The Annual Exclusion
There are numerous ways to reduce your estate’s exposure to federal gift and estate taxes. One simple, yet amazingly effective, strategy is to make use of the “annual exclusion.” The annual exclusion allows you to make yearly gifts to an unlimited number of beneficiaries valued at up to $14,000 each. If you are married, you and your spouse can use the “gift splitting” option to make gifts valued at up to $28,000. Not only are these annual gifts not subject to gift and estate taxes, but they also do not count toward your lifetime exemption limit. If you and your spouse started at age 40 making yearly gifts to four recipients, you could transfer $112,000 each year tax-free. By the time you retired at age 65 you could have transferred $2.8 million! By sheltering $2.8 million from the tax you would reduce your taxable estate further from $3.55 million to $750,000. Your tax obligation would then change from $1.42 million to $300,000.
If you have additional questions or concerns regarding federal gift and estate taxes, please join us for one of our free estate planning seminars, or contact the experienced New York estate planning attorneys at The Law Offices of Kobrick & Moccia by calling 800-295-1917 to schedule your appointment.