Part of the joy of making money and building wealth is not solely the aim to live a flexible life of convenience; it is also giving to those we love. Typically when we think of passing down money to loved ones, it is through a will drafted years earlier or even an estate plan. However, other giving strategies may help you preserve your wealth, so more of it goes to those you love.
The IRS allows lifetime tax exemptions on gifts and estates, up to a limit adjusted periodically to combat inflation. These exclusions enable people to preserve their wealth, and to pass it down to their heirs with as minimal a tax burden as possible. However, some strategies could potentially be employed to make essential decisions that may increase the exclusions’ benefits.
Are estate and gift taxes the same?
Estate and gift taxes often get mentioned together because they are subject to the same rate and share the lifetime exemption amount. However, they are different because the gift tax applies to transfers made during their life, whereas estate tax applies to transfers of the decedent’s property at death. [i]
How the estate tax exclusion works
In 2022, an individual is allowed to leave their heirs up to $12.06 million and $24.12 million for married couples before any gift becomes subject to estate tax.
How the gift exclusion works
U.S. citizens have an unlimited exemption from the property they inherit from a spouse. Your gifts to your loved ones might reduce your lifetime exemption, but there are still strategies you can apply where your loved ones have the potential to receive your gifts tax-free. One technique is the annual $16,000 gift tax exclusion. This is a different lifetime gift and estate tax exemption. In 2022 you can give a gift of up to $16,000 to as many people as you want without having to report it onto a federal gift tax return, form 709. If married, you and your spouse may each give $16,000 to an individual for a total annual gift of $32,000.
What happens if you give more than the $16,000 or $32,000 exclusion limit?
In this hypothetical scenario, if you give more than the $16,000 by, say, 10,000 dollars totaling $26,000, to circumvent the tax, you can apply that $10,000 over the exclusion amount to the lifetime exemption of $12.06 million as long as that has not been used up. The gift tax exclusion regularly increases due to inflation but cannot exceed $1,000 annually if it is increased the following year. It does not occur every year. From 2018-2021 the gift tax limit was $15,000. Then in 2022, it increased to $16,000.
How a Grantor Retained Annuity Trust (GRAT) works
A GRAT is an irrevocable financial instrument used in estate planning to minimize taxes on large financial gifts to family members. It pays you an annuity stream whereby you attempt to bring the gift tax to zero each year by the end of the term. These funds then can go to your heirs, or you can hold them in another trust to preserve the wealth against lawsuits or creditors that your heirs might owe. So, you transfer assets into the trust and receive an income stream, though that income is taxable. If you have a high income, you may want to speak with a financial professional to see if putting only a portion of your assets into a GRAT would be more beneficial. However, you may still be saving if you would end up paying a more significant percentage in estate taxes. The IRS assumes that the trust assets will generate a return of at least the applicable Sec. 7520 rate for the month the assets were transferred to the trust. Any appreciation in over the Sec. 7520 rate passes to the beneficiaries free of gift tax. [ii] It is crucial that you adhere to the IRS code when creating this trust. Thus, receiving guidance from an experienced financial professional is highly recommended.
What is portability, and how does it work?
Portability is the ability of spouses to combine their exemption from estate tax.
For the purposes of the Federal estate and gift taxes, a portability election allows a decedent’s unused exclusion amount (deceased spousal unused exclusion amount, or DSUE amount) to be applied to the surviving spouse’s subsequent transfers during life or at death. [iii]
How this works
When one spouse dies, the surviving spouse elects portability on the estate tax return and may be able to claim both their own exemption and however much of their deceased spouse’s exemption that was not used up or whatever is left over. This includes gift amounts in excess of the gift exclusion ceiling $12.06 million for an individual, $24.12 million for a married couple. To claim estate tax portability, the estate tax representative must file an estate tax return within nine months of the first spouse’s death. [iv]
There are so many different strategies that can be applied when working with finances. Developing a plan with the guidance of a qualified financial professional can help make your money work for you. Consult a financial professional and create a plan for meeting your financial goals today so that your loved ones may benefit in the future.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, consult your financial professional prior to investing.
This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.
LPL Financial Representatives offer access to Trust Services through The Private Trust Company N.A., an affiliate of LPL Financial.
All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy.
This article was prepared by LPL Financial Marketing Solutions.
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[i] Understanding Federal Estate and Gift Taxes | Congressional Budget Office (cbo.gov)
[ii] Great time for a GRAT – Journal of Accountancy
[iii] Revenue Procedure 2022-32 (irs.gov)
[iv] What Is Portability? (investopedia.com)