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Do Gifts Count Toward Estate Taxes?

Do gifts count toward estate taxes
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A recipient of a gift does not pay income taxes on the gift. However, the gift-giver may pay gift taxes, unless one of two exemptions applies.

With all of the talk about changes to estate taxes, estate planning attorneys have been watching and waiting as changes were added, then removed, then changed again, in pending legislation. The passage of the infrastructure bill in early November may mark the start of a calmer period. However, there are still estate planning moves to consider, says a recent article “Gift money now, before estate tax laws sunset in 2025” from The Press-Enterprise.

Gifts are used to decrease the taxes due on an estate but require thoughtful planning with an eye to avoiding any unintended consequences.

The first gift tax exemption is the annual exemption. Anyone can give anyone else a gift of up to $15,000 every year. If giving together, spouses may gift $30,000 a year. After these amounts, the gift is subject to the gift tax. However, there’s another exemption: the lifetime exemption.

For now, the estate and gift tax exemption is $11.7 million per person. Anyone can gift up to that amount during life or at death, or some combination, tax-free. The exemption amount is adjusted every year. If no changes to the current law are made, this will increase to roughly $12,060,000 in 2022.

The current estate and gift tax exemption of $11.7 million per person “sunsets” (expires) in 2025. This “sunset” will bring the exemption down from historically high levels to the prior level of $5 million. Even with an adjustment for inflation, this would make the exemption about $6.2 million. This change will dramatically increase the number of estates required to pay federal estate taxes nationwide.

Federal estate taxes may be less of a worry for households with a net worth below $6 million for an individual and $12 million for a married couple. However, there are state estate taxes, and some are tied to federal estate tax rates. Planning is necessary, especially as some in Congress would like to see those levels set even lower.

Let’s look at a fictional couple with a combined net worth of $30 million. Without any estate planning or gifting, if they live past 2025, they may have a taxable estate of $18 million: $30 million minus $12 million. At a taxable rate of 40%, their tax bill will be $7.2 million.

If the couple had gifted the maximum $23.4 million now under the current exemption, their taxable estate would be reduced to $6.6 million, with a tax bill of $2,520,000. Even if they were to die in a year when the exemption is lower than it was at the time of their gift, they’d save nearly $5 million in taxes.

Many estate planning gifting techniques are used to leverage giving, including some which provide income streams to the donor while allowing the donor to maintain control of assets. These include:

Grantor Retained Annuity Trusts. The donor transfers assets to the trust and retains the right to payments over a period of time. At the end of that period, beneficiaries receive the assets and all of the appreciation. The donor pays income tax on the earnings of the assets in the trust, permitting tax-free transfer of assets.

Intentionally Defective Grantor Trusts. A donor sets up a trust, makes a gift of assets. If this trust is done correctly, there is a minimal gift, no gain on the sale for tax purposes, the donor pays the income tax.

These strategies may continue to be scrutinized as Congress searches for funding sources, but in the meantime, they are still available and may be appropriate for your estate. Speak with an experienced estate planning attorney to see if you should put these or other strategies into place.

Reference: The Press-Enterprise (Nov. 7, 2021) “Gift money now, before estate tax laws sunset in 2025.”