The Gift Tax Exemption
Under federal tax law, a person can exclude gifts amounting to $15,000 from their taxable income each year. If the amount of a person’s gifts exceeded the $15,000 annual gift exclusion, they may still exempt excess amounts from their taxes up to the federal gift tax exemption threshold. This threshold applies to all gifts made during the taxpayer’s lifetime.
The gift tax exemption can be a powerful tool to protect estates from tax liability. For example, if a taxpayer made a lifetime gift of $115,000 in 2018 they could deduct $15,000 from their taxable income per the annual gift exclusion limit, and deduct the excess $100,000 per the gift tax exemption. In 2018, the threshold for the federal gift tax exemption was $10 million.
As a result, the taxpayer would only be able to exempt up to $9,800,000 in excess of the $15,000 annual exclusion for the following year. Therefore, the taxpayer can deduct a total of $9,815,000 from their taxes in 2019.
If the same taxpayer made a lifetime gift of $65,000 in 2019, they could deduct $15,000 under the annual gift exclusion, and deduct the remaining $50,000 under the gift tax exemption. As a result, the taxpayer could only deduct $9,750,000 under the gift tax exemption in 2020.
A History of the Gift Tax Exemption from 2010 to 2020
In 2010, congress passed the Tax Relief Act, which was signed into law by President Barrack Obama. Among the various reforms that the law introduced was the establishment of a $5 million threshold for gift tax exemptions, applicable to the 2011 and 2012 tax years.
Under the 2010 Tax Relief Act, provisions of the Internal Revenue Code regarding the calculation of gift taxes were amended to address a technical anomaly arising from changing tax rates. Previously, the taxation of prior gifts was calculated based on earlier rates. In some cases, the previous tax rate was higher than the rates applicable to the year when taxes were assessed. As a result, a gift tax still applied to additional gifts despite staying under the $1 million threshold of the gift tax exemption.
In 2017, the Tax Cuts and Jobs Act signed into law by President Donald Trump doubled the threshold for gift tax exemptions to $10 million.
Recently, the Internal Revenue Service announced that the gift tax exemption limit will increase to $11.58 million for the 2020 tax year.
Portability for Gifts to Spouses Upon Death
If a taxpayer passes away, their estate can go to a surviving spouse tax-free. The tax code allows the surviving spouse to apply the unused gift tax exemption of their deceased spouse and apply it to what they inherited. This is known as “portability” of the gift tax exemption.
Returning to the example above, imagine that the taxpayer passed away in 2019, leaving their estate to their surviving spouse (instead of making a lifetime gift of $65,000). Because the deceased spouse had $9,800,000 remaining of their gift tax exemption, the surviving spouse could apply it to the amount they inherited upon their spouse’s death.
If the deceased spouse’s estate was worth $9,900,000, the surviving spouse could apply the unused $9,800,000 of their spouse’s gift tax exemption to their inheritance. As a result, $9,800,000 of the $9,900,000 estate can be exempted from the gift tax. Therefore, only $100,000 of the estate would be taxable as a gift.
Most importantly, the surviving spouse can only take advantage of the gift tax exemption’s portability if the executor of the deceased spouse elected to do so in filing an estate tax return. In many states, taxpayers are not required to file estate tax returns. If an executor is not familiar with the filing requirement to take advantage of the portability of the deceased’s unused gift tax exemption, the surviving spouse would be liable for unsheltered amounts of the estate.
Understanding how these tax exclusions and exemptions work is essential to protect your estate from tax liability.
Need Estate Planning Services? Drexler Law Can Help!
At Drexler Law, our experienced estate planning attorneys are dedicated to helping you protect your assets by crafting an effective estate plan. Part of creating a comprehensive estate plan involves understanding the rules that apply to federal estate taxes, including the rules concerning gift tax exemptions and its portability.