Using Gifting To Minimize Estate Tax

Estate taxes can significantly diminish the value of an estate passed on to beneficiaries. To mitigate this, many individuals employ gifting strategies during their lifetime. This approach, when executed correctly, can reduce the size of the taxable estate and, consequently, the estate tax liability. Our friends at Stuart Green Law, PLLC provide an in-depth look at how gifting can be used to minimize estate tax:

Understanding The Basics

The federal estate tax is levied on the value of an estate before it is distributed to heirs. As of 2024, the federal estate tax exemption is $13.61 million per individual. Estates valued below this threshold are not subject to federal estate tax. However, estates exceeding this amount can be taxed at rates up to 40%. Some states also impose their own estate or inheritance taxes, which further complicate the tax landscape.

Gifting assets during one’s lifetime can reduce the size of the estate and help manage estate tax exposure. The IRS allows individuals to give away a certain amount of money or assets each year without incurring a gift tax. This annual exclusion is a critical component of an effective gifting strategy.

Annual Gift Tax Exclusion

In 2024, the annual gift tax exclusion allows individuals to give up to $18,000 per recipient without triggering gift tax reporting requirements. Married couples can combine their exclusions and gift up to $36,000 per recipient annually. By systematically gifting assets up to the exclusion limit, individuals can transfer significant wealth over time without reducing their lifetime estate and gift tax exemption.

For example, a couple with three children could gift $36,000 to each child annually, amounting to $108,000 per year. Over a decade, they could transfer over $1 million to their children, significantly reducing the size of their taxable estate.

Lifetime Gift Tax Exemption

In addition to the annual exclusion, there is a lifetime gift tax exemption, which is currently unified with the estate tax exemption at $13.61 million. This means that gifts exceeding the annual exclusion count against the lifetime exemption. Once the lifetime exemption is exhausted, any further gifts are subject to the gift tax.

The strategic use of the lifetime gift tax exemption can further reduce an estate’s value. For instance, if an individual has a $15 million estate, they can gift $13.61 million during their lifetime, leaving only $1.39 million subject to estate tax upon their death (assuming no other adjustments or deductions).

Leveraging Gifting For Estate Planning

Effective estate planning often involves a combination of annual exclusion gifts and larger, strategic gifts that utilize the lifetime exemption. Here are some strategies:

1. Outright Gifts: Direct gifts of cash, stocks, or other assets to individuals. This is the simplest method and can be repeated annually within the exclusion limits.
2. Tuition and Medical Expenses: Payments made directly to educational institutions or medical providers on behalf of another individual are not subject to gift tax and do not count against the annual exclusion or lifetime exemption. This is an excellent way to provide for loved ones while preserving more of the exclusion for other gifts.
3. Irrevocable Trusts: Placing assets in an irrevocable trust removes them from the taxable estate. Trusts can be structured to provide for beneficiaries while minimizing estate and gift taxes. For example, a Crummey trust allows beneficiaries to withdraw contributions for a limited period, qualifying the gift for the annual exclusion.
4. Family Limited Partnerships (FLPs): This strategy involves transferring business or investment assets into a partnership, then gifting partnership interests to family members. This can provide valuation discounts due to lack of marketability and minority interest, further reducing the taxable value of the gifted assets.
5. Grantor Retained Annuity Trusts (GRATs): With a GRAT, the grantor transfers assets into a trust while retaining the right to receive annuity payments for a specified term. After the term, remaining assets pass to the beneficiaries. If the assets appreciate at a rate higher than the IRS’s assumed rate, the excess appreciation transfers tax-free.

Gifting is a powerful tool for minimizing estate tax, but it requires careful planning and execution. The rules surrounding gift and estate taxes are complex, and strategies must be tailored to individual circumstances. Working with an estate tax lawyer ensures that gifting strategies align with overall financial goals and comply with tax regulations. By leveraging annual exclusions, lifetime exemptions, and advanced planning techniques, individuals can effectively reduce their estate tax liability and maximize the wealth passed on to their heirs.