In the first few months of President Biden’s administration, the focus has been on COVID-19 relief, voting rights, and infrastructure. But President Biden campaigned on changes to the tax system, and you can be sure that, sooner or later, the administration is going to try to implement those changes. In an earlier blog posts, we discussed both the current state of the law and some possible changes to the estate tax under the Biden administration.
It is said that nothing is certain in life but death and taxes. And while you cannot prevent either one, you can certainly plan for both. Here are some estate tax planning strategies that should minimize the pain of any upcoming changes to the federal Tax Code.
The unified tax credit, also known as the gift and estate tax exemption, allows individuals to make gifts during their lifetime or at death from their estate up to a certain dollar amount—the exemption amount. Gifts in excess of that amount trigger gift or estate tax. Fortunately, the exemption amount, which often changes over time, is large enough that most individuals don’t have to worry about gift or estate tax planning strategies. In 2021, this lifetime exemption amount is $11.7 million per individual, and double that amount for married couples.
Gifts you make during your lifetime would chip away at that exemption amount, if not for the gift tax annual exclusion. The exclusion lets you make gifts to as many people as you wish each year without using up any of your exemption amount, so long as the gifts do not exceed $15,000 per year, per recipient. If you are married, you and your spouse can give each recipient up to $30,000 per year—$15,000 from each of you. Doing so during your lifetime gradually reduces the size of your taxable estate while preserving your lifetime gift and estate tax exemption.
Suppose that you and your spouse have three children, nine grandchildren, and enough assets that your estate might be vulnerable to estate tax. If you wait until your death to transfer assets to your children and grandchildren, the amount of your estate that exceeds the exemption amount will be subject to estate tax. However, if you and your spouse make use of the gift tax annual exclusion, you can gift $30,000 to each child and grandchild annually, removing $360,000 from your estate each year.
(Uncomfortable making large gifts to individuals who might not be mature enough to handle them? Consider creating a trust, such as a Crummey trust.)
Many of our clients are accumulating wealth with the intention of helping to pay for their grandchildren’s education. If you have a similar motivation, you can remove assets from your taxable estate using your gift tax annual exclusion in a particular way.
You may have heard of 529 plans, which are a type of savings account earmarked for education (usually college). But you may not have realized that you can contribute five years’ worth of your annual exclusion to a 529 plan at once. Together with a spouse, you could fund each grandchild’s account with $150,000—and remove that amount from your taxable estate.
Your child or grandchild doesn’t have a 529 plan account, and you don’t want to set one up? No problem. You can make direct tuition payments to the college they attend and still make an annual exclusion gift of $15,000 (or $30,000 if married) to the child. Be aware, however, that this might affect your children’s or grandchildren's eligibility for financial aid to the extent that they qualify.
If you have a family member who would inherit from your estate, but they have significant medical expenses today, you can simultaneously benefit them and reduce the size of your taxable estate. It’s quite simple: you can make payments directly to a third party (their medical providers) on their behalf without triggering the gift tax annual exclusion or using up any of your unified credit. For a loved one struggling with health issues and the burden of large medical bills, wiping out those bills now might be even more welcome than the prospect of a large inheritance later.
Near the beginning of this blog post, we mentioned that the estate and gift tax lifetime exemption changes over time. That was something of an understatement. The 2017 Federal Tax Cuts and Jobs Act (TCJA) doubled the lifetime exemption, with annual adjustments for inflation. However, the exemption is scheduled to decrease to $5 million under that law—and the possibility exists that the Biden administration could seek to reduce the exemption sooner, and perhaps to a lower amount.
What happens if you make a large gift now, while the exemption is high, and the exemption is later reduced below the value of the gifts you have made? The Internal Revenue Service has confirmed that large gifts will be “grandfathered in” in the event the lifetime exemption is later reduced; in other words, no tax would be due on the previous gifts.
Given the certainty that the lifetime exemption will decrease in a few years, and the possibility that it will decrease sooner, it may make sense to go ahead and make large gifts that will use up part of your exemption now. Put simply, this may be a “use it or lose it” situation.
Before making any large gifts, it is a wise idea to consult with your estate planning attorney to ensure there are no unintended consequences to a move intended to save on taxes. Your attorney will be able to help you identify estate tax planning strategies that are best for your unique circumstances and assist in making sure everything is reported correctly to the IRS. With multiple offices in Ohio, we invite you to contact Gudorf Law Group to learn more.