Estate Tax Strategies You Can Do Every Year: Use your annual gifting exemption and other ideas

Gifting is one of the most effective ways to reduce estate tax liability and transfer wealth to future generations. When structured properly, gifting can help individuals minimize their taxable estate and potentially avoid a significant estate tax hit upon their passing. However, understanding how to maximize these benefits requires knowledge of the relevant tax rules and strategies.

Understanding Gift Taxes and the Annual Exclusion

The IRS provides an annual exclusion for gifts, meaning that individuals can give away up to a certain amount of money or property each year without it being counted toward their lifetime gift tax exemption. For 2024, the annual exclusion is set at $18,000 per recipient. This means that an individual can gift $18,000 to any number of people without having to file a gift tax return or reduce their lifetime gift tax exemption.

• How the Annual Exclusion Works: You can gift $18,000 to as many individuals as you like without triggering a gift tax. This limit applies to each recipient, not the total amount of gifts. For instance, you can gift $18,000 to your son, $18,000 to your daughter, and $18,000 to a friend in a single year without any tax implications.

• Gift Splitting: Married couples can combine their gift tax exclusions, effectively doubling the amount they can give to each recipient tax-free. If you are married, you and your spouse can jointly give $36,000 per recipient per year.

Lifetime Gift and Estate Tax Exemption

In addition to the annual exclusion, there is also a lifetime gift tax exemption. As of 2024, the lifetime exemption is $13.61 million. Any gifts exceeding the annual exclusion count toward this lifetime exemption, but you won’t owe gift taxes until your cumulative gifts surpass the exemption amount.

• How the Lifetime Exemption Works: If you give more than $18,000 to a single person in one year, the excess is deducted from your lifetime exemption. For example, if you gift $38,000 to one person in 2024, you use up $20,000 of your lifetime exemption ($38,000 - $18,000 annual exclusion = $20,000).

• Estate Tax Connection: The lifetime gift tax exemption is tied to the estate tax exemption. Any amount used during your lifetime reduces the exemption available for your estate. If you gift $4 million during your life, your estate will only have $9.61 million exempt from estate tax upon your death.

Gifting to Reduce Estate Taxes

The key to using gifts for estate tax savings is to start planning early and to gift assets that are likely to appreciate in value over time. By gifting these assets now, you can remove future appreciation from your taxable estate, potentially saving your heirs a significant amount in estate taxes.

• Example: Suppose you own a property worth $500,000 that you expect to appreciate significantly in the coming years. If you gift this property to your children now, its current value is removed from your taxable estate. If you wait and the property appreciates to $1 million, you will have to include the full $1 million in your estate calculation. By gifting earlier, you avoid the estate tax on that appreciation.

• Discounts on Gifting: Certain types of assets may qualify for valuation discounts when transferred as gifts. For example, gifts of minority interests in family businesses or partnerships may be discounted for lack of marketability or control, effectively reducing the gift’s value for tax purposes while still transferring the same amount of economic value.

529 Plans: Educational Gifting

A 529 plan is a tax-advantaged account designed to help families save for education. Contributions to a 529 plan are considered gifts, but they allow the donor to retain control over the funds for the benefit of the recipient’s educational expenses.

• Superfunding 529 Plans: One unique feature of 529 plans is the ability to “superfund” the account by front-loading five years’ worth of annual exclusion gifts. For example, you could contribute $90,000 to a grandchild’s 529 plan in a single year ($18,000 x 5 years) without triggering a gift tax, as long as you do not make any further gifts to that individual in the following four years.

• Educational Expenses: If the funds in a 529 plan are used for qualified educational expenses, they grow tax-free, and withdrawals are also tax-free. This makes 529 plans a powerful gifting tool, especially for those looking to support their children or grandchildren’s education.

Direct Payments for Medical and Educational Expenses

In addition to the annual gift tax exclusion, the IRS allows individuals to make unlimited tax-free gifts by paying directly for someone’s education or medical expenses. These payments do not count toward your annual exclusion or lifetime exemption, making them a great way to transfer wealth without triggering any gift tax implications.

• Educational Expenses: Payments made directly to an educational institution for tuition are excluded from gift tax. This can include payments for your children, grandchildren, or even someone else’s children, provided the payment is made directly to the school.

• Medical Expenses: Similarly, payments made directly to a healthcare provider for someone else’s medical expenses are excluded from gift tax. This includes payments for hospital bills, doctor visits, and even long-term care.

Charitable Gifting

Charitable giving is another strategy to reduce your taxable estate. Gifts made to qualified charities are fully deductible for estate tax purposes and can also provide income tax benefits during your lifetime.

• Charitable Remainder Trusts (CRTs): A CRT allows you to transfer assets into a trust, where the income from those assets can be paid to you or your beneficiaries for a certain number of years. After that period, the remaining assets go to charity. This strategy provides a way to reduce your taxable estate while still generating income for yourself or your heirs.

• Donor-Advised Funds (DAFs): A DAF allows you to make a charitable gift today, take an immediate tax deduction, and recommend grants to charities over time. This strategy provides flexibility in charitable giving while still reducing your taxable estate.

Irrevocable Trusts

Irrevocable trusts are a key tool in estate planning and gifting strategies. By transferring assets to an irrevocable trust, you remove those assets from your taxable estate, and any future appreciation in the assets also escapes estate taxation.

• Grantor Retained Annuity Trusts (GRATs): A GRAT is a type of irrevocable trust that allows you to transfer appreciating assets to your beneficiaries with minimal or no gift tax. You place assets in the trust and receive annuity payments for a specified period. After the trust term ends, any remaining assets go to your beneficiaries. The value of the gift is determined at the time the trust is established, so any appreciation in the assets during the trust term passes to your beneficiaries tax-free.

• Irrevocable Life Insurance Trusts (ILITs): An ILIT is used to remove life insurance proceeds from your taxable estate. You transfer ownership of your life insurance policy to the trust, and the trust becomes the policy’s beneficiary. When you pass away, the life insurance proceeds are paid to the trust and distributed to your heirs without being subject to estate tax.

Gifting Appreciating Assets

Gifting assets that are likely to appreciate in value is a smart way to reduce your taxable estate. This can include stocks, real estate, or interests in a family business. When you gift these assets, their current value is removed from your estate, and any future appreciation is not subject to estate tax.

• Gifting Stocks: Gifting shares of stock is a common strategy, especially for those who own large amounts of publicly traded stocks or closely held business shares. By gifting the shares today, you remove them from your estate, and any future appreciation in their value is not subject to estate tax.

• Family Limited Partnerships (FLPs): An FLP allows you to transfer interests in a family business to your heirs while retaining control over the business. FLPs can also provide valuation discounts, which reduce the taxable value of the gift.

You Got This: Plan Early for Maximum Benefits

Estate planning and gifting strategies should be implemented as early as possible to maximize their tax-saving potential. By making gifts over time and utilizing the various tools available, you can significantly reduce your estate tax liability and ensure that more of your wealth is passed on to your heirs.

Tax laws surrounding gifting and estate planning can be complex, so it’s important to consult with a qualified tax advisor to ensure that your plan is structured in the most tax-efficient manner.