One common goal of estate planning, aside from deciding who will receive your estate assets when you die, is tax avoidance. Failing to consider the impact of gift and estate taxes on your estate plan can be catastrophic considering the fact that estates are taxed at a 40 percent tax rate. For anyone with a moderate to large estate a significant portion of the estate can be lost to taxes without careful planning. One estate planning tool that is frequently overlooked is the annual gift tax exclusion. Using the annual gift tax exclusion you can gift money each year to your children tax-free.
When you die, your estate assets are potentially subject to gift and estate taxes. The value of all gifts made during your lifetime is added to the value of all assets owned by you at the time of death. Because each taxpayer is entitled to exempt up to the lifetime exemption amount which was set at $5 million, adjusted annually for inflation, in 2013, $5.34 million (if you die in 2014) is then deducted from the total. The remaining amount is subject to gift and estate tax. Imagine, for example, that you die in 2014, leaving behind an estate valued at $4.5 million. You also made eligible gifts during your lifetime valued at $3 million. Your total gifts and assets are $7.5 million, of which $2.16 million is subject to gift and estate tax. (7.5 – 5.24 = $2.16 million). Your estate would lose $864,000 to taxes ($2.16 million x .40 = $864,000).
The annual gift tax exclusion could prevent the loss of a significant portion of your assets. The annual gift tax exclusion allows you to make gifts valued at up to $14,000 to as many beneficiaries as you wish each year tax-free. Moreover, gifts made using the annual exclusion are not counted toward your lifetime exemption amount. To illustrate, let’s say you have four children and six grandchildren. If you gift the maximum amount to each beneficiary each year for ten years you can transfer $1.4 million is assets tax-free prior to your death. In the above example, that would remove $1.4 million is assets from you taxable assets at the time of death, leaving only $760,000 in taxable assets. That, in turn reduces your gift and estate tax burden from $864,000 to $304,000, leaving an extra $560,000 in assets for your family and loved ones.