There is a federal estate tax that can come into play if you want to transfer large amounts of money to your heirs. The line in the sand that stands between those who must pay the tax and those who are exempt exists in the form of the federal estate tax credit or exclusion.
In 2014, the amount of this exclusion is $5.34 million, and the maximum rate of the estate tax is 40 percent.
Federal Gift Tax
If you are exposed to the federal estate tax, you would logically consider giving gifts to your loved ones while you are living to avoid the tax. This used to be possible shortly after the estate tax was enacted in 1916, but a gift tax was subsequently enacted to close this loophole.
The federal gift tax and the estate tax are unified under the tax code. The $5.34 million lifetime exclusion applies to taxable gifts that you give while you are living along with the value of the estate that you are passing on to your heirs. This tax also carries a 40 percent top rate.
Annual Gift Tax Exclusion
In addition to the $5.34 million lifetime gift and estate tax exclusion, there is also an annual gift tax exclusion. This exclusion allows you to give up to $14,000 to any number of gift recipients within a calendar year free of the gift tax.
To be clear, this exclusion is completely separate from the unified gift and estate tax exclusion. In other words, if you gave $14,000 to each of your five children on New Year’s Day, you would not be reducing the amount of your available unified exclusion.
If you gave each child $1 million six months later, you would use up $5 million of your $5.34 million unified lifetime exclusion. There would be just $340,000 left to apply to your estate and any future lifetime gifts that you may give.
We should point out the fact that you do not have to use any type of exclusion to transfer assets to your spouse tax-free. There is an unlimited marital estate tax deduction. This allows you to transfer unlimited property to your spouse at any time free of federal transfer taxes.
Additional Gift Tax Exclusions
There are two additional gift tax exclusions that we should touch upon. You can pay medical expenses for other people free of the gift tax, and this can extend to the purchase of health insurance for the benefit of someone else.
You can also pay school tuition for students without incurring any gift tax exposure. This exclusion is a tuition-only exclusion that does not extend to books, fees and living expenses.
Free Special Report
We have prepared a special report on federal transfer taxes. This report will provide you with some in-depth information, and it is being offered free of charge.
To access your copy, click this link and follow the simple instructions: Free Estate Tax Report.
Joe Masiuk, Estate Planning Attorney
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