Cash Gifts Now Can Help You Avoid the Estate Tax Later
'Tis the season for giving. So think about taking advantage of the annual gift tax exclusion before the year ends.
Imagine the look on your grandchild's face when he rips the wrapping paper off your holiday gift, opens the lid, and sees a box full of cash. That'll move you to the top of the "favorite grandparents" list pretty quickly. But giving money to family or friends can also be a smart tax planning move. For wealthier Americans, giving away cash now can help you reduce or even avoid estate taxes when you die.
The general rule is that any gift is subject to the federal gift tax. However, there's an important exception to this rule—you can give up to $15,000 per person during the year without having to file a gift tax return. If you're married, your spouse can also give $15,000 to the same people, jacking the annual tax-free gift up to $30,000 per person. So, for example, if you're married and have three married children and six grandchildren, you and your spouse can give up to $30,000 this year to each of your kids, their spouses and all the grandchildren without even having to file a gift tax return. That's $360,000 in tax-free gifts! And you can do that year-after-year without paying any gift tax unless the total of all your non-exempt gifts over the years exceeds the lifetime limit, which is $11.58 million for 2020 ($11.7 million for 2021). But since the $15,000 (or $30,000) limit is an annual limit, you have to make your gifts before the end of the year (gift checks must also be deposited by December 31).
And here's the added bonus: Whatever you give away this year, up to the $15,000 per recipient limit, won't be counted for estate tax purposes when you die. So, for example, if the current value of your estate is above the federal estate tax exclusion amount ($11.58 million for 2020 and $11.7 million for 2021), giving away money now could drop the value below the exclusion amount, which would mean no federal estate tax when you pass away. Also keep in mind that the estate tax exclusion amount will fall to $5 million (plus an inflation adjustment) in 2026, unless Congress permanently adopts the current amount. President-Elect Joe Biden is in favor of reducing the exclusion amount. So, even if your estate is not worth more than the exclusion amount now, it might be after 2025…or even sooner. (IRS regulations also guarantee that tax-free gifts you make now won't trigger estate taxes if/when the exclusion amount is lowered.) There could be state estate taxes to worry about, too—12 states and the District of Columbia have their own estate tax, and all of them have exclusion amounts far below the current federal standard (as low as $1 million in Massachusetts and Oregon).
Even if giving away money now doesn't allow you to completely avoid estate taxes, you'll still reduce the estate tax owed by reducing the value of your estate. Plus, you can make family and friends very, very happy!