Let me begin this guide with a disclaimer. The information set forth herein is for educational purposes only and should not be construed as legal advice. It is also based on the Gift and Estate Tax laws as of the date of this writing and does not take into consideration unknown changes to the law which may take place in the future.
All transfers of assets are the same, right? No, not exactly. Gifts are transfers of assets to an individual, charity, or other entity during your lifetime, i.e., before you pass.
Inheritance is the transfer of assets to your heirs or beneficiaries by virtue of your death, either through your estate plan or through intestacy (the State’s default estate plan).
To the IRS, the timing of your generosity makes little difference. Lifetime gifts can also be beneficial if you think your death and the succession of your assets will create fighting among your family.
Currently the Gift and Estate Tax exclusions amounts are unified, meaning lifetime transfers and transfers upon death count equally against your lifetime tax exclusion amount – currently set at $5.45 million ($10.9 million for married couples) and tied to inflation. Practically speaking, if your assets fall within that (those) amount, whether you give it all away during your lifetime or pass it on after you pass, the tax ramifications will be the same. However, there is one difference between gift and estate tax, and that’s the annual gift tax exclusion.
The IRS allows every person to give $14,000 per year to as many people as they would like, and $28,000 for married couples, without having it apply against the lifetime exclusion amount. This is called the Annual Gift Tax Exclusion. That means married couples can give each of their kids (and grand-kids) $28,000 each year and still have the full $10.9 million exclusion when they pass. This applies to value generally, it doesn’t necessarily have to be cash or cash equivalents.
Likewise, the IRS allows an unlimited amount of assets to pass between spouses without having any impact on the lifetime exclusion amounts.
Some people who own near or over the estate tax exclusion amount, and thus likely to have some estate tax liability after they pass, will use lifetime gifts to their family to draw down their taxable estate without impacting their lifetime exclusion amount. For example, consider the following:
Joe has a taxable estate (the amount of assets subject to estate tax after you pass) of $6 million (which would be $550,000 over the exclusion amount and would subject his estate to potential estate taxes in the amount of approximately $220,000). He has three (3) children and three (3) grand children. Joe is in his 70’s, but in good health. Absent an accident or unexpected illness, he’ll likely live for quite a while. In order to reduce his taxable estate to at or below the exclusion amount ($5.45 million), Joe decides to transfer to each of his kids and his grand kids $14,000 each year for the next 7 years ($84,000 per year, $588,000 over 7 years). If he is successful in making such gifts prior to his death, without any further growth of this taxable estate, he will have a taxable estate of $5.412 million, $38,000 under the estate tax exclusion amount. He has both conveyed a value of $588,000 to his family prior to his death, and also saved his family $220,000 in taxes after his death. Win-win for Joe and his family.
This example will not apply equally to all families – some will be much less liquid and lifetime gifts may be more difficult to give without impacting the lifetime use of assets or the overall value of assets.
Any sort of plan implementing lifetime gifts should be developed and overseen by an experienced estate planning attorney and CPA.