Should I Use my Annual Exclusion During my Lifetime?

One of the most important goals of estate planning is reducing estate taxes.  Before your estate can be distributed to your heirs, after your death, the IRS will be sure to collect its share.  In 2015, that would equate to 40% of your total assets over $5,430,000.00.

Luckily, there are certain exclusions allowed each year, which allow a portion of your assets to be given away tax-free.  However, many clients ask this question: “should I use my annual exclusion during my lifetime?”  In some cases, the answer is yes.

The benefit of federal estate and gift tax exclusions

Estate taxes are certainly a legitimate estate planning concern. But, the “unified credit” can allow you to transfer a rather large portion of your estate to your heirs and beneficiaries without being subject to estate taxes. This credit is composed of the federal estate and gift tax exclusions. 

In 2015, the estate tax exclusion is $5.43 million.  This means that your entire estate can pass to your heirs tax free, as long as it does not exceed that amount.  With this amount, most people will not need to worry about estate taxes at all.

What happens if my estate exceeds $5.43 million?

Basically, the IRS will assess an estate tax on any amount of your estate that exceeds $5.43 million.  However, there are many ways that you can reduce, or maybe even eliminate, your tax liability.  Again, this is one of the goals of estate planning.  Trusts and life insurance policies, for example, can help with this issue.  Another common way to reduce your estate tax liability is through the gift tax exclusion.  This is where many people question whether to use the exclusions while they are living, or save the full exclusion until their death.

How the Gift Tax Exclusion works

Whenever you give someone a gift, meaning you transfer ownership of property to someone else for less than its full value, the IRS may impose a gift tax if the value is over $5.43 million.  If the value of the gift is greater than $14,000, but less than $5.43 million, then the IRS requires that a gift tax return be prepared.  A person’s $5.43 million exclusion is reduced by the amount the gift exceeds $14,000.

However, each person can take advantage of the annual gift tax exclusion of $14,000 per recipient and no reduction of the $5.43 million exclusion is required.  This exclusion can be doubled by spouses who choose to give joint gifts.

Why it is good to use your exclusion during your lifetime

It is sometimes better to give away your money during your lifetime, as opposed to leaving it to your heirs.  An article published in Charles Schwab explained it this way:  imagine if you had four quarters, and you died still owning all four quarters.  If the gift tax was 50% for instance, the IRS would take two quarters and your heirs would only have two quarters left.

Now, if you took those same four quarters, and gave your heirs two quarters during your lifetime, you would only have two quarters left when you died.  Then the IRS, taking 50%, would only have one quarter, and you would still be left with one quarter.  This way, your heirs still receive their two quarters, but you will still have a quarter left to give away after your death.

If you have questions regarding estate taxes, or any other estate planning needs, please contact Wilcox Attorneys, PA online or by calling us at (479) 443-0062.