The federal estate tax can have a very significant impact on your legacy. It carries a 40 percent rate, and most people would say this is a very heavy dose of taxation.
We are going to provide some information about the estate tax in this post, and we will highlight a change that will kick in when the new year rolls around.
Estate Tax Exclusion
Before you get too worried about the 40 percent hit, it is very likely that you will not be forced to pay the tax. There is a credit or exclusion that can be used to transfer a certain amount tax-free. The amount that exceeds the exclusion would potentially be subject to taxation.
The estate tax was repealed throughout 2010 because of a provision contained within the Bush era tax cuts. It was scheduled to return in 2011 with a $1 million exclusion, but a fresh piece of legislation provided some tax relief.
A $5 million exclusion was put into place at that time, and the rate was set at 35 percent. In 2009, the exclusion was $3.5 million, but the rate was 35 percent, so there was a give-and-take.
The rate went down to 40 percent when yet another tax law went into effect in 2013, and the exclusion remained constant at $5 million with ongoing inflation adjustments.
In December of 2017, the Tax Cuts and Jobs Act was enacted, and it changed the exclusion for 2018. It went up to $11.18 million, and the rate did not change.
In 2020, the adjusted exclusion has been $11.58 million, and the IRS has announced an increase for 2021. The exclusion will stand at $11.7 million during the 2021 calendar year.
We should point out the fact that the exclusion that we have right now is higher than it has ever been by a very high margin. The relevant provision in the aforementioned Tax Cuts and Jobs Act will sunset or expire at the end of 2025.
At that time, the exclusion is scheduled to revert back to the 2017 figure of $5.49 million adjusted for inflation. A new tax law may be passed between now and then that alters the current trajectory, and we will certainly share that information if and when it becomes available.
Marital Deduction and Portability
There is an unlimited marital estate tax deduction, so you can leave unlimited property to your spouse tax-free.
The exclusion is portable between spouses, so a surviving spouse can use the exclusion that was allotted to their deceased spouse. Portability is a relatively new phenomenon that was part of the tax bill that went into effect in 2011.
Federal Gift Tax
You might consider lifetime gift giving as a way to get around the federal estate tax if you have a large estate. This makes sense on the surface, but there is a gift tax in place that closes this loophole.
The multimillion dollar exclusion is a unified exclusion that applies to gifts that you give while you are living and the estate that will be transferred after your death, with one caveat.
There is a $15,000 per year, per person additional gift tax exclusion that sits apart from the unified exclusion. You can give this much to any number of gift recipients in a calendar year tax-free without using any of your unified exclusion.
There is an educational gift tax exclusion that gives you the ability to pay school tuition for others without incurring any transfer tax liability. You can use the medical exemption to pay health care bills for others in a tax-free manner, and this would include the payment of health insurance premiums.
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