Many people plan to pass on money and property to their loved ones after they die. However, if you have a sizable estate, you need to consider using a combination of lifetime gifting and gifts at your death to ensure your heirs receive all you have spent a lifetime saving and not risk your estate being hit with federal estate taxes (often called “death taxes”) at your death. Read on to learn about estate taxes and how to plan your estate gift.
What is an estate tax?
There are five different types of taxes you and your heirs should be aware of when it comes to inheriting assets from your estate:
- An estate tax, sometimes called the “death tax,” is levied against your estate after you pass and before your assets are transferred to your heirs.
- An inheritance tax is State tax that applies to an heir who resides in a State that has inheritance taxes, where the State taxes your heir or beneficiary for the value of the assets left to them at your death. Virginia doesn’t have an inheritance tax, but if one of your heirs lives in a State that does levy inheritance taxes, such as Maryland, those rules may apply to your estate.
- A gift tax is reporting mechanism while you’re living, by which you report to the IRS any gifts you make to any person in a single calendar year that exceed $16,000 per year; then, at your death, the IRS totals all your lifetime gifting that exceeding the $16,000, plus all the assets you have left through your estate when you die, and if it exceeds the lifetime gifting limits (discussed below), your estate will owe taxes to the IRS for exceeding these limits. Special rules also apply to gifts made to grandchildren, called generation-skipping transfer taxes.
- State estate taxes vary based on how they typically tax property transferred from your estate to your heirs. Virginia does not impose gift, inheritance, or estate taxes.
- The federal estate tax is the tax the federal government levies against your estate at your death if your estate exceeds a certain exempt amount (called the “allowable amount”). Even though Virginia doesn’t impose an estate tax, you may still have to pay the federal estate tax.
Under the current federal law, the federal tax exemption in 2022 is $12.06 million — increased from $11.70 million in 2021 — and it applies to both spouses. This means that with the help of an estate planning attorney, a married couple can protect up to $24.12 million after they pass. An estate that exceeds these allowable amounts will incur a 40% tax on every dollar which exceeds the $12.06 million allowable amount for individuals or $24.12 million for couples after the last of them dies.
The increased exemption amounts, established in 2018, will expire at the end of 2025. In 2026, the exemption amounts will revert back to $5.49 million per person and $10.98 million per married couple (indexed annually for inflation). Strategic lifetime or inter vivos gifting can reduce the size of your taxable estate before your death, and help your beneficiaries avoid this hefty financial burden.
Qualified gifting is the complete and irrevocable transfer of assets from one person to another, where the giver does not receive anything in return. Certain IRS exemptions allow you to make these gifts tax-free, provided their values fall within federal limits (currently $16,000 per person per year for 2022). Going above these allowable amounts means that you, as the giver, are obligated to report the gift to the IRS and pay a federal gift tax.
If you want to use gifting as an estate planning tool, you’ll need to plan out your giving and time it properly, so you and your loved ones can avoid as much estate-related taxation as possible. Here is a basic overview of annual and lifetime gifting exemptions, and how you can make the most of them.
Annual gift tax exclusion
For the tax year 2022, the annual gift tax exclusion allows you to give any single individual up to $16,000 per calendar year, tax-free — an increase from $15,000 in 2021. So, for example, if you have two children and give each of them $16,000 this year (or $32,000 if you are married and you and your spouse “split” the gift), you do not need to pay the gift tax. However, if you give one child $17,000 in a single year, $1,000 is considered taxable and counts against your allowable lifetime gift amount.
If you exceed the $16,000 limit, then, as the giver of the gift, you must report this to the IRS when you file your regular income tax return on April 15 of the following year.
Lifetime gift tax exemption
The lifetime gift tax exemption is connected to the estate tax exemption: The $12.06 million limit is the combined amount you can give away before your death and leave to others after you pass without being subject to federal taxes. This means that if you give away $6.03 million in non-exempt gifts while you’re alive, only $6.03 million of your remaining estate is tax-exempt, and your estate must pay taxes on anything beyond that amount.
Suppose you are married at the time of your death. In that case, your surviving spouse is entitled to their individual exemption plus any of your unused exemption if you properly invoke portability in your estate plans. You must also consider that the estate tax exemption or “allowable amount” will return to its previous $5.49 million individual limit in 2026 subject to a cost-of-living adjustment, which likely means that the total allowable amount will be around $7 million. If you are young and unlikely to pass away before then, you’ll want to adjust your gifting plans accordingly.
If your estate is more than $12.06 million, the simplest way to avoid gift and estate taxes is to bequeath your money and property to your loved ones while you’re alive rather than waiting until you pass. There are two distinct advantages to giving away your estate to your loved ones while you’re alive:
- It allows your heirs to grow your estate through strategic investments, which can decrease your total taxable estate and allow your heirs to receive their inheritance tax-free.
- You’ll be around to see your loved ones enjoy your gift and benefit from your generosity.
If you’re concerned about your heirs responsibly managing their inheritance, create an irrevocable trust and name your loved one as the beneficiary. As the owner of the estate, you can establish the stipulations of the irrevocable trust, including how your heirs should invest or distribute the assets they inherit. Meet with an experienced estate planning attorney to discuss your options.
Exceptions to the rules
There are a few gifting scenarios that do not count toward the above limits:
- Marital gifts. If both spouses are U.S. citizens, they can make unlimited lifetime gifts to each other without paying taxes on those gifts.
- Medical and educational gifts. Payments made directly toward a dependent/beneficiary’s medical services or education (e.g. tuition expenses) are not included in your lifetime gifting amount. For example, if you settle your family member’s hospital bill directly with the hospital, you can still gift your loved one up to $16,000 annually tax-free. Making gifts from your estate in this manner also reduces the total of your taxable estate.
- Charitable gifts. You do not have to pay gift tax on gifts given to qualifying organizations like charities, religious or educational institutions, government agencies, and 501(c)(3) tax-exempt organizations.
Take a look at our blog post to learn more about gifting, including specific information about Virginia’s state laws.
Talk to an estate planning attorney about gifting
If you’re considering making gifts to reduce your taxable estate, connect with an experienced attorney who can educate you on federal gift tax laws and other implications of lifetime giving. You can also work with your estate planning lawyer to create a strategic gifting plan that reduces your taxable estate while leaving you enough to support yourself.
The Law Office of Patricia E. Tichenor, P.L.L.C. has been assisting Northern Virginia individuals with their estate plans since 2001, and we’d love to help you create the best strategy for your family’s future. Schedule your free consultation today to talk about your unique estate planning needs.