The new tax law for 2018 has brought a big change in the amount of money you can give away during your life and at your death without having to pay gift or estate tax. Through the end of 2025, a single individual can now give away $11.18 million, up from $5.49 million in 2017, without paying gift or estate tax. A married couple can give away $22.36 million, up from $10.98 million in 2017. That’s more than double the amount of tax-free giving possible.
While these lifetime exemption increases are straightforward, how they tie into the additional rules surrounding gift and estate tax can be complicated. Here is a quick refresher on how those rules work.
Gift and Estate Tax: What You Need to Know
All gifts made by U.S. citizens or residents during their lifetimes, aside from gifts to spouses and charities, are subject to gift tax. Gift tax is paid by the gift giver, not the gift receiver. But not all gifts subject to tax regulations require the giver to file a gift tax return or pay gift tax: Each year you are allowed to give up to $15,000 (for 2018) to anyone without having to do so. This annual gift tax exclusion amount covers the gifts most people give in the course of everyday life.
Any amount you gift during the year that is greater than the annual gift tax exclusion (i.e., amounts greater than $15,000) is potentially subject to gift tax. For example, if you gave $20,000 to a friend who was going through hard times, $5,000 of your gift may be subject to gift tax. Whether that $5,000 is actually subject to gift tax depends on you having already reached the lifetime exemption amounts noted above. If your lifetime gifts have reached $11.8 million as a single person or $22.36 million as part of a married couple, then that $5,000 would be subject to gift tax; if you haven’t reached those limits, then the $5,000 would not be subject to gift tax.
These lifetime exemption amounts apply to more than just gifts made during your life; they also apply to what is given away at your death and so affect your estate tax. Estate tax is a tax on your remaining assets that you are passing to heirs at your death. Similar to how some gifts made during your lifetime are exempt from gift tax, a certain amount of your gifts at death (bequests) are exempt from estate tax.
In fact, the gift and estate tax are combined, using the same tax rate schedule and exemption amount: As long as the total of your lifetime gifts (above the annual exclusion amount of $15,000 per person) and the amount you pass on to heirs at death is below the exemption amount, you won’t owe any gift or estate tax. For example, a single person making gifts of $3 million during her lifetime and leaving an estate of $7 million for her children won’t owe estate or gift tax because the total value of gifts and her estate at death was less than $11.18 million. If instead she had given gifts of $5 million and left an estate of $10 million, though, $3.82 million would be subject to estate tax.
Married couples face an extra twist. Spouses are allowed to give an unlimited amount of money to each other during their lifetimes or at death. If one spouse dies and leaves everything of their share of the joint assets to the remaining spouse, none of those assets will be subject to estate tax or be applied toward the deceased spouse’s lifetime exemption amount. In a case like this, there may be an unused portion of the exemption remaining. (There may be an unused portion of a deceased spouse’s exemption resulting from other situations as well.)
A feature of the estate law allows the remaining spouse to then use any unused portion of a deceased spouse’s exemption amount. For example, if a married couple’s joint estate is $20 million and the first spouse to die gifted their half of the estate to the other spouse, then the remaining spouse’s estate is $20 million. At the remaining spouse’s death, they will use their exemption amount of $11.18 million (assuming no previous gifts and the spouse dies in 2018) and $8.82 million of the first spouse’s exemption amount. None of the estate will be taxable.
This feature of the estate law is known as “portability” and requires filing an estate tax return at the death of the first spouse. With portability, the combined gift and estate tax exemption amount is effectively doubled to $22.36 million.
A Temporary Change
With the increase in the lifetime exemption amount under the new 2018 tax law, very few households need to worry about paying gift or estate tax over the next few years. However, the exemption increase is only temporary. It will expire December 31, 2025, after which the exemption will return to 2017 levels (which would be adjusted for inflation through 2025): $5.49 million for individuals and $10.98 million for married couples using portability.
People with a net worth that could approach these 2017 limits will need to monitor this area of tax law closely. While Congress may vote to extend the current law out past 2025, a future Congress could also revise the law to return the exemptions to lower amounts such as $2 million or $3 million, which have existed historically.
With this in mind, it’s important to create an estate plan that will work under a wide range of gift and estate tax scenarios. Regardless of the exemption amount, estate planning is vitally important to ensure your assets go where you want them to go upon your death.
