One of the most effective estate planning tools for persons looking to reduce their estates for gift and estate tax purposes is to make “annual exclusion” gifts each year to their loved ones in lower generations. Typically, such gifts are made in January. In this way, should the donor pass away later in the year, the opportunity to make annual exclusion gifts will not have been lost.
The annual exclusion is the largest amount that an individual can give in any particular year to each of their loved ones without incurring federal gift taxes or reducing their lifetime exemption from gift and estate taxes. (The lifetime exemption, known technically as the “applicable exclusion amount,” is the aggregate amount that an individual may give during lifetime and at death without incurring federal gift or estate taxes.) The annual exclusion is indexed for inflation so it increases in amount in some years. This year, however, the IRS has announced that the annual exclusion will remain at $13,000, the same figure it has been since 2009.
To demonstrate the power of annual exclusion gifts, suppose that a married couple in their sixties has four adult children, all of them married, and ten grandchildren in all. Each grandparent can make an annual exclusion gift to each of their four children, their children’s four spouses (if desired), and their ten grandchildren. That amounts to eighteen annual exclusion gifts per grandparent, or thirty-six gifts in total. Multiplied by the annual exclusion amount of $13,000, those thirty-six gifts will reduce the grandparents’ combined estates by $468,000 in a single day without any adverse gift or estate tax consequences.
If one spouse is wealthy and the other is not, the wealthy spouse can make all of the gifts and, with their spouse’s consent, treat the gifts as made one-half by each of them. (This is referred to as “splitting gifts.”) As a result, the non-wealthy spouse can in effect make annual exclusion gifts that they otherwise could not afford.
Gifts between spouses are usually disregarded for gift and estate tax purposes, a consequence of the gift and estate tax unlimited marital deduction. An exception arises, however, if one of the spouses is not an American citizen. Gifts by an American citizen to their spouse do not qualify for the marital deduction. Instead, to partially compensate for the loss of the marital deduction, gifts to a non-citizen spouse are subject to an augmented annual exclusion amount. For 2012, that figure is $139,000, up from $136,000 in 2011. Gifts not exceeding $139,000 will therefore be disregarded for gift and estate tax purposes.
Of course, as the law stands today, relatively few people need concern themselves with federal gift and estate taxes because the lifetime exemption from those taxes (for American citizens and non-citizens who are domiciled in the US) stands at $5,120,000 per person. However, this is a temporary arrangement between Democrats and Republicans in the nation’s capital, a political stalemate. New laws are supposed to be in place effective January 1, 2013. What those laws will provide no one can say.
Be aware that most states also impose estate or inheritance taxes, and a few even impose gift taxes. New York has no gift tax, and the exemption from estate taxes is fixed at $1,000,000. The maximum estate tax rate in New York is 16%. With very high federal exemptions in place, the focus in estate planning is shifting from federal to state estate and inheritance tax savings.