The Tax Cuts and Jobs Act of 2017 increased the federal estate tax exemption to $11.18 million for 2018. That’s per person, so the combined exemption for a married couple can be as much as $22,360,000 worth of
assets this year. The same ceilings apply to the federal gift tax, which offsets the estate tax.
Mona McAfee plans to give $20,000 to her son Luke this year. Does that mean that Mona’s estate tax exemption would be reduced to $11,160,000? Probably not. In addition to the lifetime exemption numbers now in effect, there is also an annual gift tax exclusion. Due to an ongoing process of inflation adjustment, that exemption increased to $15,000 in 2018. Therefore, in 2018, each person can give up to $15,000 to any number of recipients without incurring gift tax consequences. That’s up from an annual $14,000 exclusion, which was in effect the previous five years. Here, Mona’s $20,000 would be partially covered by the $15,000 exclusion, so only $5,000 will have gift tax consequences. Mona would have to report a $5,000 taxable gift on IRS Form 709. That $5,000 taxable gift will reduce her current federal estate and gift tax exemption amount to $11,175,000, assuming no other taxable gifts have been made. As the recipient of the gift, Luke will pay no taxes.
Real World Relevance
Most people won’t have estates close to $11 million, so this exercise might seem academic. Still, the $15,000 annual gift tax exclusion can have practical effects in many situations. It’s also worth noting that paying someone else’s medical or education bills directly won’t be included in the $15,000 allowance.
Rhonda Cole wants to provide financial support for her son Mark’s two children, Ken and Julie. To do so, Rhonda pays tuition bills for Ken and Julie directly to their colleges. The total is $50,000. In addition, Rhonda gives them each $15,000 in 2018 and no other gifts. Rhonda also decides to give Mark $15,000 this year and pays $5,000 worth of bills from Mark’s medical procedures directly to the health care providers. In total, Rhonda has given $100,000 to her loved ones, reducing her taxable estate by that amount. However, she hasn’t gone over the $15,000 exclusion for any recipient in 2018, so Rhonda hasn’t made any taxable gifts and will not have to file for a gift tax return. Note that the $15,000 limit presents a handy ceiling for making family gifts each year without the bother and expense of filing a gift tax return. This strategy won’t work as well if Rhonda gives Mark $50,000 so Mark can pay his children’s college bills. Then, Rhonda will have made a taxable gift of this amount and will be required to file form 709.
Other possibilities exist if a married couple holds assets jointly, perhaps in a bank or brokerage account. A gift from such an account, or a gift of other property, by one spouse can be considered to be divided equally between the two spouses, so the annual gift tax allowance effectively increases to $30,000 annual exclusion by electing “gift Splitting” on Form 709.
Don’t neglect estate planning
The federal estate tax exemption now exceeds $11 million per person. Accordingly, few individuals or married couples will owe this tax. Nevertheless, there is more to successful wealth transfer than reducing or eliminating estate tax. Ideally, you’ll want your assets to pass to the desired recipients with a minimum of turmoil and expense.
To start, you should have a will prepared by an experienced attorney. Your will should not only name specific heirs for specific assets, but also identify an executor who will administer your estate and, if relevant, guardians who will care for your any minor children. Once your will has been prepared, don’t file it away and forget about it. Review the document periodically, especially after major life events such as births, deaths, marriages, and divorces. In addition to a will, other efforts should be included in your estate planning.
Many assets will pass to a beneficiary or co beneficiaries at your death. They include retirement accounts, annuities, and life insurance proceeds, as well as certain bank and investment accounts. The good news is these assets usually pass without having to go through probate, which might be expensive and time consuming.
The bad news? Generally, a beneficiary designation will override what’s in a will. Keeping beneficiary designations current can be vital. Except when a legal agreement is in place, you probably won’t want assets to pass from an ex- spouse under an old beneficiary form.
Employer-sponsored defined contribution retirement plans, such as 401(k)s, may be required to pass to a surviving spouse, unless a waiver has been signed. Complying with such rules may save your heirs from an unhappy ending.
In recent years, revocable trusts (also known as living trusts) have become popular. As the name indicates, these trusts can be undone, with trust assets reverting to the trust creator, known as the grantor. Meanwhile, the creator continues to control the assets in the trust and have access to income from such assets. Assets transferred into such trusts can avoid going through probate at the creator’s death. As mentioned previously, retirement plans and other assets avoid probate anyway.
The same is true for assets held as joint tenants with right of survivorship- such property passes to the surviving owners. Therefore, probate avoidance applies to other types of assets if they are held in a revocable trust. To get this benefit, assets must be transferred into this trust. Beyond probate avoidance, revocable trusts might also reduce administrative expenses by helping the trustee to identify and gain control over the assets. Additionally, a revocable trust can be valuable in the case of incapacity. Control of trust assets may pass to a successor trustee or co- trustee.
Nancy Hunter creates a revocable trust into which she transfers her bank accounts, investment accounts, and real estate. Nancy names her daughter Judy Palmer, as successor trustee. Now, if Nancy loses the ability to manage the trust assets, Judy will take control. Before naming someone as successor or trustee, consider this question: Is this person able or willing to serve? If not, a corporate co- trustee may be the answer. The latter solution will cost money but could be less expensive than the losses caused by an unqualified trustee.
With irrevocable trusts, the grantor gives up control of assets transferred into the trust. Such trusts can serve many purposes, such as reducing estate tax, protecting beneficiaries who might handle money unwisely, and providing strong creditor protection. Modifying an irrevocable trust can require considerable effort and expense, if it can be done at all.
A thorough estate plan also might include a letter of instruction, durable power of attorney, and health care directives. The lawyer who drafts your will and any trusts you might desire can let you know what else you’ll need for a comprehensive estate plan.