Creating a comprehensive estate plan requires more than simply deciding who will receive your assets when you are gone. Along with making those decisions, you must think about protecting and growing your assets while you are alive as well as the impact of estate taxes at the time of your death. Failing to consider the impact of federal gift and estate taxes could result in the loss of a significant chunk of your estate. Every dollar lost to Uncle Sam in estate taxes is one less dollar your loved ones will receive from your estate. With that in mind, it only makes sense to consider ways to avoid estate taxes when you create your estate plan.
What Is the Federal Gift and Estate Tax?
The federal gift and estate tax is a tax imposed by the federal government at the time of your death. The tax is levied on the value of all qualifying gifts you made during your lifetime combined with the value of all assets owned by you at the time of your death, or in which you had an ownership interest at the time of your death. For example, if you made gifts valued at $4 million dollars during your lifetime and owned assets valued at $6 million at the time of your death, the combined total of $10 million would potentially be subject to federal gift and estate taxation at the rate of 40 percent. Without any further deductions or exemptions, your estate would owe a staggering $4 million in federal gift and estate taxes!
What Is the Lifetime Exemption?
Fortunately, not all of your estate is subject to federal gift and estate taxes. Each taxpayer is entitled to exempt up to the lifetime exemption limit from his/her estate before gift and estate taxes are imposed on the estate. Historically, the lifetime exemption limit fluctuated on a regular basis; however, in 2012 the American Taxpayer Relief Act (ATRA) permanently set the lifetime exemption limit at $5 million, adjusted annually for inflation. For 2016, the lifetime exemption limit is $5.45 million. Therefore, you can exempt up to that amount from your estate. In the above example, that means your estate would only owe federal gift and estate taxes on $4.55 million after deducting the lifetime exemption limit. Of course, that still leaves a tax bill of $1.82 million.
How Else Can I Avoid Federal Gift and Estate Taxes?
Clearly, the lifetime exemption helps to limit the impact of federal gift and estate taxes; however, for anyone with a moderate to large estate it may not be enough to completely avoid the tax altogether. Because every estate is unique, it is always best to consult with an experienced North Dakota estate planning attorney to determine the best way for your estate to avoid federal gift and estate taxes; however, some common strategies include:
- Unlimited marital deduction – you have the option to gift an unlimited amount to a spouse, tax free, when you die. The problem with relying on the marital deduction is that it often over-funds a spouse’s estate, essentially just prolonging the inevitable payment of estate taxes. Using the above example, imagine that you left your $4.55 million in assets to a spouse but your spouse also owned assets valued at $4 million. That leaves your spouse with an estate valued at $8.55 million for federal gift and estate tax purposes. Even after using his/her lifetime exemption the estate will incur taxes.
- Annual exclusion – the annual exclusion allows you to make gifts valued at up to $14,000 to an unlimited number of beneficiaries each year tax-free. If you are married, you may use the gift-splitting option to make joint gifts valued at up to $28,000. Best of all, these tax-free gifts do not count toward your lifetime exemption limit. If you made just four gifts each year you could transfer $56,000 each year tax-free. Over the course of just ten years you could transfer $560,000 tax-free!
- Trusts – certain specialized trusts can help you defray the impact of federal gift and estate taxes by transferring wealth without incurring taxes or at least limiting the impact of taxes.
For more information, please join us for one of our upcoming free seminars. If you have additional questions about estate taxes in the State of North Dakota contact the experienced estate planning attorneys at German Law by calling 701-738-0060 to schedule an appointment.