We all know the expression that there are only two certainties in life: death and taxes. We just don’t always think about the collision of these two forces at the worst possible time if we neglect strategic lifetime tax planning. The good news is that here at Rockwood, we are already thinking about and planning for this component of your financial plan. What is this elephant in the distance and why should you care? We’ll come back to the elephant in a minute but first let’s unpack a few estate tax concepts and what it all potentially means for you and your loved ones.
When you decide to give a financial asset to somebody you love, the government may tax that gift. Generally speaking, it’s better to give away assets while you’re alive rather than after you pass away but there are many aspects to consider including the health of your personal balance sheet, the type and titling of your assets, the size of your portfolio, and even the personality and needs of your heirs. Fortunately, a large portion of your gifts and estate can be excluded from taxation by understanding the annual gift tax exclusion and the lifetime gift and estate tax exemption (aka unified tax credit).
What is the annual gift tax exclusion?
Individuals can gift up to $16,000 (for 2022) per recipient per calendar year without reducing their lifetime exemption, mandating the reporting of the gift to the IRS, or paying federal gift tax. If you are married and meet certain requirements, you and your spouse can give $32,000 per recipient per calendar year.
Now back to that elephant….
The elephant represents the potential reduction of the lifetime exemption amount under the unified tax credit.
What is the unified tax credit and how does it work?
The unified tax combines gift and estate taxes into one tax system and provides a set dollar amount that individuals can gift during their lifetime before gift or estate taxes apply. The $12.06 million federal exemption applies to gifts and estate taxes combined – any portion of the exemption you use for gifting purposes will reduce the amount you can use for the estate tax at the time of your passing. Each donor has a separate lifetime exemption, and each married couple can combine their exemptions to get a total exemption of $24.12 million. Therefore, the current exemption, assuming a married couple, sets the exemption amount so high that very few people should be concerned about crossing above that threshold. But there’s one caveat with current law so let’s look at the history and the potential future of the unified tax credit.