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Once we were old enough to earn a paycheck, we learned that the Internal Revenue Service exerts a massive pull on our wallet. Thus, the IRS is similar to gravity: Both are powerful forces that are always at work, and we feel their effects from the cradle to the grave.
Amassing and managing vast amounts of wealth generates a unique set of complex issues, as does passing it along to others. A deeper understanding of taxes, coupled with proper estate and gift tax planning, is essential for eliminating blind spots and safeguarding assets. Who knew that feeling generous and giving away a fortune could induce such anxiety?
Federal Income Taxes Are Imposed On The Transfer Of Property From Person To Person
The amount of tax liability is determined by the gross value of the transfer. The U.S. estate tax rate on this transfer is a steep maximum rate of 40%. At the time of the taxpayer’s death, the fair market value of all assets — the gross estate — is calculated. All property in which the decedent had an interest, stocks/bonds, mortgages, cash, life insurance and jointly owned property falls under the umbrella labeled “gross estate.”
December 2019 marked the second anniversary of the signing of the Tax Cuts and Jobs Act. While the act made sweeping changes for many ordinary taxpayers, it handed extremely wealthy Americans a sweetheart of a deal.
Unpacking The Numbers
In 2017, the exemption amount was a trivial $5.49 million, but in 2018, it soared to $11.18 million. Thus, the minimum threshold for taxation doubled. This gravity-defying exemption is not permanent; it’s a limited-time offer. It will revert back to previous levels on January 1, 2026.
Estate Taxes
After the decedent passes and the property transfer occurs, estates are required to file an estate tax return provided the value of the gross estate, less certain deductions, exceeds a specified dollar amount.
• Personal exemptions in 2020 are $11.58 million, which is a little bump up from $11.4 million in 2019. For those who fall into this bracket, it’s good news, as this jaw-dropping deduction is per individual. The amount will be adjusted annually for inflation.
• Marital deductions can be transferred tax-free to a spouse, as long as the spouse is a U.S. citizen and the property is a direct transfer to the spouse.
• Certain miscellaneous deductions are permitted.
Surviving The State Estate Tax Liability
Thus far, the focus has been on federal estate tax liability, but only the ultra-wealthy will be required to pay taxes. The Tax Policy Center estimates that less than 2,000 estates fall into this federal tax camp. However, the stakes are high if you reside in one of the 18 states and territories that tacks on estate/inheritance taxes. When a billionaire dies in one of these locations, estate taxes will produce significant revenue streams.
For example, when dynasty-building Walmart founder James Walton died 25 years ago, Arkansas’ tax receipts skyrocketed 425% the following year. Depending on each state’s laws, the estate may be liable for taxes. In other states, taxes will be the responsibility of the property’s recipient.
Caring Is Sharing — And Gifting
Gift taxes refer to the transfer of property prior to death. Giving away money and gifts is something that many taxpayers enjoy. High net worth individuals are no different, except that they have larger amounts at their disposal. During the sunset years, it can be tempting to give away the bulk of their assets to avoid paying taxes. The IRS is way ahead of the curve; it has already planted a flag in the gift tax soil to ensure it harvests a bumper crop.
• What is considered a gift? The Internal Revenue Code (IRC) considers a gift to be any property transferred to a nonspouse beneficiary, providing that no cash or other monetary value was exchanged. However, if the giver receives something in return that is equal to or exceeds the particular gift’s full market value, then it is not considered a gift. The giver is typically the one stuck with the tax bill, but the receiver may be tapped to pay a percentage.
• What’s allowed? Cash gifts of $15,000 or less are exempt. If married, you and your spouse may give away $30,000 and not be required to file a gift tax return.
Navigating The Exclusion Maze
To reduce the amount of gift tax owed, taxpayers should consider the following exclusions:
• Marital gift: As long as the spouse is a U.S. citizen, you may give away any amount with no taxes due.
• Education and medical expenses: Feeling charitable? Paying for someone else’s tuition or medical bills is a noble gesture. A bonus is that your acts of kindness will not generate tax bills. However, these funds must be paid directly to the medical facility, care provider or higher educational institution. Keep the money out of the hands of the individual.
• Charitable donations: Philanthropic taxpayers who make contributions to qualified charities may double-dip: They may claim the value of the donation on their itemized individual income tax return as well as deduct the value from the gift taxes owed.
• Gifts to political organizations: Any amount given as a political contribution may be excluded from taxes, providing there is no third party involved.
Regardless of how quietly you managed to strike it rich, alarm bells will sound in the land of the IRS, alerting them to follow your money. Off in the distance, you will hear them revving up their astronomical calculators to determine your net worth and the value of your gross estate. May the odds be in your favor as you prepare for control of your empire.
Full disclosure. The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.