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If you’re fortunate enough to give away substantial amounts of money or property during your lifetime, your generosity may be subject to federal gift tax rules.
After death, your money and property, known as your estate, may also be subject to federal estate tax. However, you can give money away during your lifetime or leave certain amounts to your heirs that are exempt from taxation.
After years of congressional battles, the estate tax was made a permanent part of the Internal Revenue Code, thanks to the American Taxpayer Relief Act of 2012, or ATRA, which was passed Jan. 1, 2013.
ATRA increased the amount of an estate that is not subject to taxation, known as the exemption, to $5 million. The exemption amount is indexed each year for inflation. For the 2016 tax year, the estate tax exemption is $5.45 million. It increases to $5.49 million for 2017.
ATRA also increased the tax rate on estates in excess of the exemption amount from 35 percent to 40 percent.
The estate tax law, however, does offer permanent portability between spouses. This allows the surviving spouse the opportunity to take advantage of any unused estate and gift tax exemption left by the first spouse. The portability option must be selected when the estate tax return of the first spouse is filed, even if no federal estate tax is owed.
Annual gift tax exclusion
|Year made||Excluded from tax|
You can give the following monetary amounts to each person and to as many individuals as you want without triggering the gift tax. The amount is indexed from time to time for inflation.
In addition to the annual exclusion amounts, you also can give the following without triggering the gift tax:
- Charitable gifts.
- Gifts to a spouse.
- Gifts to a political organization for its use.
- Gifts of educational expenses are unlimited as long as you make a direct payment to the educational institution for tuition only. Books, supplies and living expenses do not qualify.
- Gifts of medical expenses are also unlimited, as long as they are paid directly to the medical facility.
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In estate planning, you also must consider the unified credit. It gets its name because the federal gift tax and estate tax are integrated into one unified tax system.
This is the credit for the portion of estate tax due on taxable estates. For example, if you exceed the annual gift tax exclusion amount in any year, you can either pay the tax on the excess or take advantage of the unified credit to avoid paying the tax. The unified credit enables you to give away $5 million (plus the annual inflation adjustments) during your lifetime without having to pay gift tax.
By using the unified credit during your life, you’ll reduce the amount available to offset the estate tax upon your death. If, however, you pay the gift tax, such taxed gifts are added back to your estate, and the estate tax is recalculated, with the gift taxes you previously paid credited against any final estate tax due.