The federal estate tax was initially enacted in 1916. If you were around at that time, and you found out that your estate was going to be taxed, what would you do? Clearly, you would resolve to give gifts to your loved ones that would eventually be inheriting them anyway to avoid the tax.
People could take advantage of this window of opportunity for about eight years, but in 1924, lawmakers were able to push a gift tax through the legislature. It was repealed in 1926, but it was reenacted in 1932. This levy has been a part of the tax code ever since then.
During the 1970s, the gift tax and the estate tax became unified. There is a unified lifetime gift and estate tax exclusion that allows taxpayers to transfer a certain amount before the tax would become applicable. At the time of this writing in 2022, the exclusion is $12.06 million.
We should point out the fact that there are no gift or estate taxes on transfers between spouses, as long as the people involved are American citizens. There is a solution that can be utilized to gain estate tax efficiency if you are married to a citizen of another country, and we will cover that in another post.
Additional Gift Tax Exclusions
In addition to the unified exclusion that we touched upon above, there are some added gift tax exclusions that can be utilized to reduce your estate tax exposure. One of them is the annual gift tax exclusion, and the amount of this credit is $16,000 per person right now.
You can give up to $16,000 to any number of gift recipients within a calendar year free of taxation without cutting into your unified lifetime gift and estate tax exclusion. This may not sound like a lot of money for someone that has more than $12.06 million, but it can add up.
For example, let’s say that you have five married children, and you are married yourself. You and your spouse would each have individual gift tax exclusions to utilize, so you could combine them to give $32,000 to each husband and each wife annually.
That works out to $320,000 each year, so you could transfer quite a bit of money in a tax-free manner if you give these gifts on a consistent basis year in and year out. It should be noted that this exclusion can be used to fund certain types of trusts, and it can be utilized to facilitate tax efficient transfers among members of a family limited partnership.
There is no greater gift than the gift of education. If you would like to pay school tuition for students, you can do so without incurring any tax responsibility. This being stated, the educational gift tax exclusion is a tuition only exemption. It does not extend to books, fees, and living expenses.
However, you could use your $16,000 per year gift tax exclusion to provide additional support in a tax-free manner, and you can double that if you are married.
Another gift tax exemption is the medical exclusion. Under the IRS regulations, you are permitted to pay medical bills for others without being taxed. There is no limit to the total amount that you can cover, and this includes health care insurance premiums.
State Level Gift and Estate Taxes
A number of states in the union have estate taxes on the state level. In these states, the exclusions are usually considerably lower than the federal estate tax exclusion. As a result, you could be exposed to a state estate tax even if you are exempt on the federal level.
As luck would have it, there is an estate tax in Illinois, and the exclusion is far lower than the federal exclusion at $4 million. However, there is no gift tax. For your information, there are 12 states with estate taxes, and Connecticut is the only one with a gift tax.
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Our doors are open if you are ready to work with a Naperville or North Aurora, IL estate planning attorney to put a plan in place. If you have estate tax concerns, we can recommend a tax efficiency strategy, and we are here to help if taxation is not going to enter the picture.
You can set the wheels in motion right now if you give us a call at 630-568-8611, and you can use our contact form to send us a message.