The Internal Revenue Service (IRS) recently announced that the estate and gift tax exemption is increasing next year: up from $11.18 million per individual in 2018 to $11.4 million in 2019.
This means that if an individual dies in 2019, she can leave $11.4 million to heirs and pay no federal estate tax. Using a concept called estate tax portability, a married couple can shield double that amount, $22.8 million, from estate taxes.
The IRS also confirmed that the annual gift exclusion amount for 2019 remains at $15,000 per individual per year, unchanged from 2018. This means you can give $15,000 to as many people you want (me, for instance) each year without filing a gift tax return.
Now that we have these big announcements out of the way, let’s unpack what all this fun information actually means.
What is the estate tax exemption?
The estate tax is a federal tax imposed on estates over a certain value. That “certain value” is known as the “estate tax exemption” or “combined estate and gift tax exemption” or “unified credit” or a dozen other names.
The main thing to know is this: if an estate is worth more than the exemption amount, the value over the exemption amount will be taxed. If the estate is worth less than the exemption amount, no tax liability.
In other words: the higher the exemption amount, the fewer estates will have to pay taxes.
For the past 8 years, the estate tax exemption had been pegged at $5 million and indexed to inflation, meaning the exemption would rise about 2% per year from that $5 million base.
However, the Trump tax cuts (the Tax Cuts and Jobs Act, signed in December 2017) effectively doubled that base exemption amount. Using numbers:
In 2017, before passage, the exemption amount was $5.49 million per person.
In 2018, after passage, the exemption amount is $11.18 million.
Considering 0.2% of estates had to pay any estate tax in 2017, such a significant increase (exactly double) in the exemption amount means only the mega-wealthy need to worry about estate tax planning at the moment.
In fact, the Tax Policy Center estimates that the average estate subject to estate taxes is worth about $48 million. And those estates that do owe estate taxes only pay an average rate of about 16.5%. Let’s go back to numbers:
In 2017, before the tax cut, approximately 6,500 estates paid estate taxes.
In 2018, after the tax cut, it is estimated only 1,890 estates will pay estate taxes.
BUT — and this is a big “but” — the Trump tax cuts are scheduled to expire after 2025, meaning the estate tax exemption will revert to its inflation-indexed base of $5 million. While that still won’t affect most of us, high-value individuals should keep an eye on how (or if) the law changes before 2026.
As with all tax-related matters, there are arguments for an against the estate tax.
Proponents argue that wealthy individuals find ways to reduce their tax burden during their lifetime, often resulting in a lower effective tax rate than middle class families; the estate tax ensures the wealth pay their fair share.
On the other hand, opponents of the estate tax argue that it amounts to a double tax: the individual was taxed on the income during their lifetime and are taxed again on the wealth after death.
(For further reading, and to be able to impress your friends with tax knowledge, see my article explaining how estate taxes are different than inheritance taxes.)
Do I owe gift taxes?
Remember how I said that the estate tax exemption was really a combined estate and gift tax exemption? Here’s what that means.
The gift tax “annual exclusion amount” means that you can give up to $15,000 per year to as many individuals as you want without filing a gift tax return. You can exclude that $15,000 from a gift tax return. But what happens if you give more than $15,000 to someone?
Here’s an example: Let’s say John’s assets are worth $11.15 million, which is below the $11.18 million estate tax exemption amount. If he died today, his estate would owe no estate taxes.
But John doesn’t die today. Instead, John gives Mary $115,000, or $100,000 more than the annual exclusion amount for 2018. Because he gave over the exclusion amount, John must file a gift tax return documenting the gift.
However, he won’t actually owe taxes when he files the return.
Rather, his combined estate and gift tax exemption is reduced by $100,000 — the amount he gave over the annual exclusion. So if he dies later, his remaining estate tax exemption would be $11.08 million. That means if his estate is worth $11.15 million at his death, he would owe estate taxes on $70,000 ($11.15 million - $11.08 million) of his estate.
Confused yet? That’s okay. It’s confusing for everyone. And it’s really not even as simple as the above explanation makes it out to be.
For most people, gift taxes will not be a concern since the combined estate and gift tax exemption is so high. However, you are still required by law to report gifts over the annual exclusion amount on a gift tax return (IRS Form 709).
Sometimes gifts can be used strategically to avoid estate taxes or to minimize other problems after death. Other times, gifts can cause adverse tax consequence. For that reason, it is always a good idea to talk to an attorney before making a major gift — even if you don’t think you will have to worry about paying estate taxes.
Minimize taxes through estate planning
Estate and gift taxes are a complicated estate planning topic. Misunderstanding these concepts, or failing to adequately prepare for them, can have dire consequences for your beneficiaries and loved ones.
To learn how to minimize or avoid estate taxes, or to take other actions to protect your hard-earned assets, contact the experienced Oklahoma City estate planning attorneys at Postic & Bates today for a free, no-obligation consultation.
David M. Postic is an associate attorney at Postic & Bates, P.C. His practice includes estate planning, probate, real estate, adoption, business law, and litigation.
You can email David through our Contact Us page or by calling our office at (405) 691-5080.
[As with all our posts, the contents of this article do not constitute legal advice and are subject to our site-wide disclaimer.]