The amount of money you can give to loved ones during your life and leave to your loved ones at your death has increased for 2023!  Gifting money during your life can be a great tax avoidance strategy.   There are, of course, some limits to this. 

Before we get into this strategy, let’s define some terms. 

Gift tax:  A tax on the transfer of property by one individual to another while receiving nothing, or less than full value, in return.

Estate tax: A tax on the net value of the estate of a deceased person before it is distributed to the heirs

Annual Gift Tax Exemption:  A limit on how much an individual can transfer to another each year without paying a gift tax.

Lifetime Gift and Estate Tax Exemption:  the total amount you are allowed to give to people during your life and at your death before taxes need to be paid.

In 2017, Congress passed the Tax Cuts and Jobs Act, which basically doubled the lifetime exemption at the time.  Each year since, there have been slight increases to account for inflation. People can take advantage of the gift tax and estate tax exclusion limits to lower the amount of taxes their estate will pay at their death.  So, how does this work?

Gift Taxes

Each person can gift money to an individual each year without either party paying any taxes.  This is the yearly gift tax exemption amount.  In 2022, an individual could gift $16,000 to a person under this exemption.  In 2023, that amount is increasing to $17,000.  There are no limits to how many people a person can gift money to each year. 

Here’s a common example.  A married couple has three children.  In 2023, each person can gift each child $17,000 tax free.  That means Child A can receive $34,000, Child B can receive $34,000, and Child C can receive $34,000. 

This is a yearly exemption, meaning it renews every year.  If the married couple wanted to, they could continue this yearly gift for each of their children for the rest of their lives and no taxes would need to be paid (provided Congress does not change the relevant tax code provisions).

Estate Tax

When a person dies, they can pass on their assets, up to a threshold amount, to their beneficiaries free from taxes.  In 2022, this threshold amount was $12.06 million for an individual and $24.12 million for a married couple. In 2023, this increased to $12.92 million for an individual and $25.84 million for a married couple.  Anything over that threshold number is taxed at 40%. 

For instance, if the married couple above died with $30 million in assets, the amount above the exclusion limit of $25.84 million would be $4.16 million.  At a 40% tax, the estate would need to pay $1.664 million dollars in taxes before the assets are distributed to your heirs.

Even though the estate is responsible for paying estate taxes, the tax reduces the amount that a person’s beneficiaries would inherit.

Here’s Where it Can Get Tricky:  The Yearly Gift Tax Exemption v. Lifetime Gift and Estate Tax Exemption

As mentioned above, in 2023 each person can give $17,000 to a person (and as many people as they wish each year), tax free.  This is the yearly exemption that renews every year. 

What happens if a person gifts more than $17,000 to a person?

Well, that amount over the $17,000 exclusion is then deducted from the available lifetime gift and estate tax exemption amount.  You begin to eat into your lifetime exemption.  This is because the Lifetime Gift and Estate Tax Exemption is considered a “unified credit” by the IRS. 

But I Own Far Less than the $12.92/$25.84 Million Exemption Amount, Why Should I Care About This Strategy?

First, just being able to gift money to your loved ones while you are living, without them or you having to pay any taxes on it, is a great way to help them through life.  Your gift funds can help them purchase a home, open a business, pay off some student loans, go on a great trip, or just help them make ends meet.  Even if you don’t think the lifetime exemption amount will ever apply to you, you should at least consider taking advantage of the yearly Gift Tax Exemption.  This will give you the opportunity to see your assets make a difference in your loved ones’ lives.

Second, the exemption is set to expire in 2025 if Congress doesn’t do anything to make this change permanent.  In 2026, the exemption amount goes back down to $5.49 million (which will be adjusted for inflation and is projected by the Congressional Budget Office to be $6.4 million).  If you own a house, life insurance policies, retirement accounts, investment accounts, etc, you could find yourself quickly approaching the $5.49 million exclusion.  Anything over $5.49 million, will be taxed at 40%.  (Additionally, you should look to your state of residence to see if they have a state estate tax.  Illinois does and it is currently at $4 million and it doesn’t matter if you are married or single).

The expiration of the $12.92 million exemption amount after 2025 only highlights the importance of regularly reviewing your estate plan with your attorney.  You may be leaving money to the government and not your loved ones. 

You should consult a tax professional or estate planning attorney when determining how to use the gift and estate tax exemption as part of a tax/estate planning strategy to make sure there are not any unintended consequences.

At the Law Office of Meghan Stokes, we are happy to discuss these strategies with you and see how they can benefit your family and your estate plan. Reach out now!