Estate and Gift Tax Exemptions: Maximize the Benefit

All of us have heard the saying; there are two things certain in life: death and taxes. However, what you may have yet to learn is that both can occur at the same time. The Federal Estate tax (aka, the “death tax”) is a tax that is levied on the value of a decedent’s net assets upon their death. This tax, which currently carries a maximum tax rate of 40%, can significantly impact the wealth that one could transfer to their intended beneficiaries/heirs.

To be subject to the “death tax,” we need to first look at what happens during life. Every individual has a “Basic Exclusion Amount” (also known as “Estate/Gift Tax Exemption”) which follows an individual throughout their life up until death. We’ll refrain from discussing wealth transfers to skip generations (i.e., ignoring the Generation-Skipping Transfer Tax). This is the amount of money/property an individual can gift/bequeath during life or at death to avoid paying a Federal Tax. During life, this is called “Gift Tax,” and at death, it is called “Estate Tax.” Currently, for the year 2023, the Basic Exclusion Amount (BEA) is $12,920,000.

Coinciding with the BEA is the annual exclusion amount, which is an amount that an individual can gift to another individual each year without reducing the BEA and/or triggering “gift tax;” there is no limit to the number of recipients to which an individual can gift to. For the year 2023, this amount is $17,000 for each individual taxpayer, and if the taxpayer is married, this annual exclusion is $34,000 per couple. Any amount gifted within a calendar year that exceeds these annual exclusion amounts will begin to reduce the BEA of the individual. Once the BEA amount has been exceeded, a “Gift Tax” will be due (which has the same rate as the death tax). Whatever BEA remains at death, the individual can transfer his/her assets “Death Tax” free to beneficiaries/heirs. Anything in excess of the remaining BEA at death will be assessed the “Death Tax,” and the individual’s estate will be responsible for payment, thereby reducing the amount to beneficiaries/heirs.

Gift tax is not the only factor that could reduce the basic exclusion amount. An upcoming tax law change could pose a major risk to the goal of wealth protection. The 2017 Tax Cuts and Jobs Act (TCJA) doubled the basic exclusion from $5,000,000 to $10,000,000 (to be adjusted annually for inflation). Given the recent rise in inflation, the BEA amount of $10,000,000 has since increased to $12,920,000 in 2023. After the tax year 2025, however, the TCJA rules governing estate/gift tax will sunset and revert to pre-TCJA levels if new legislation has not been enacted. With the potential reversion back to pre-TCJA amounts, an individual could lose more than $2,500,000 in tax savings and wealth protection (in comparison to 2023 amounts). This creates an essential tax planning scenario as the upcoming years’ approach and uncertainty in the tax law looms.

Along with maximizing the gifting of the basic exclusion amount, other strategies, such as direct gifting to an educational institution for the education of an individual, could help move wealth while simultaneously avoiding gift/estate tax. The same also applies to medical service payments for individuals. These gifts, which need to be made directly to the institutions themselves (not the individual), allow an individual to transfer wealth and provide benefit to their intended beneficiary without eating into their basic exclusion amount or triggering a gift tax.

Once again, death and taxes are inevitable, and it is certain that “you can’t take your assets with you.” Although our lives do end, passing down wealth to benefit those we care about is a wonderful way to keep a legacy alive and the goal should be to protect that wealth as best as possible to provide the most significant benefit to the ones we love.

Careful planning and discussions with your tax advisor are highly recommended. For more information, or if you have any questions about this or any other tax matter, please contact your WilkinGuttenplan advisor or email us at [email protected].