Proven Strategies in Uncertain Times

Congress is contemplating major changes to estate and gift tax laws. Simple strategies can lessen the impact of those changes.

Changes to federal gift and estate tax laws are likely coming as a result of the recent shift in power in Washington, D.C. While the Federal Government imposes taxes on transfers of assets both during life and at death, current law allows for the transfer of up to $11.7 million tax-free thanks to what is known as the “estate and gift tax exclusion amount.” This exclusion amount is likely to be reduced to $3.5 million or less for estates and $1 million for lifetime gifts. This will have a drastic impact on many families and will result in the imposition of substantial estate and gift taxes. The final amounts and how much additional taxes households will pay is currently unknown.

Compounding this legislative uncertainty is the fact that tax changes can be imposed retroactively, meaning that changes to the estate and gift tax laws may apply as of January 1, 2021, even if they are passed later in the year. This means that individuals may make large gifts in 2021 that they believe will not result in the imposition of any tax, only to later discover that the transfer resulted in hefty taxes because it exceeded the new estate and gift tax exclusion amount.

If the estate and gift tax exclusion amount is drastically reduced, individuals may need to utilize strategies that reduce the size of their estate while at the same time preserving as much of their estate and gift tax exclusion amount as possible.

There are two simple estate planning strategies that individuals can employ to remove assets from their estate that will likely not be affected by upcoming tax legislation – “annual exclusion gifting” and “direct payment of tuition and medical expenses.” These strategies can be used without triggering current taxes and without reducing your estate and gift tax exclusion amount.

Annual Exclusion Gifting

Under the Internal Revenue Code, when determining the amount of taxable gifts that an individual has made each year, the first $15,000 to each recipient does not count against your estate and gift tax exclusion amount. (See I.R.C. § 2503(b) – This amount is adjusted for inflation.) This means that a parent can gift $15,000 to each of their children (or any person) each year, and preserve their full estate and gift tax exclusion amount for later use. A married couple can increase the amount to $30,000 to each child or other person. Because the amount is not included when calculating taxable gifts, it does not cause a reduction in the donor’s estate and gift tax exclusion amount, and is not otherwise subject to a transfer tax.

If the gift is of a present interest, it can be placed into trust for the individual and held for their benefit. This creates a long-term wealth transfer planning opportunity that can be used for children and grandchildren, regardless of age. For example, a married couple with two children and four grandchildren can effectively shift $180,000 out of their estate every year, regardless of changes to the estate and gift tax exclusion amount. Importantly, if the trusts are structured correctly, the gift to the grandchildren will also be free of generation skipping tax, which is an additional tax imposed under certain circumstances. With proper planning, the annual exclusion gift is a powerful tool to reduce the size of a potentially taxable estate and shift assets to the next generation tax-free.

Direct Payment of Tuition and Medical Expenses

The Internal Revenue Code also allows for the direct payment of tuition and medical expenses without reducing the estate and gift tax exclusion amount. (See I.R.C. § 2503(e).) The payments must be made directly to the educational institution or medical provider – they cannot be paid through an intermediary such as a parent or the patient. While a parent’s payment of their own minor child’s tuition and medical expenses is typically considered an obligation of support and not a gift, this is not the case for grandparents. As a result, the direct payment of tuition or medical expenses is an effective strategy for grandparents looking to reduce the size of their estate without cutting into their estate and gift tax exclusion amount.

Educational expenses include tuition to private nursery school, kindergarten, elementary school, middle school, high school, and college, but not other expenses like books, supplies or rent. This creates a valuable opportunity for grandparents to pay tuition or medical expenses directly, as opposed to passing wealth on to their children as part of their taxable estate.

Given the potential tax changes on the horizon, individuals should consider these strategies in order to reduce the size of their taxable estate while at the same time preserving their estate and gift tax exclusion amount.

This article is intended for general informational purposes only. It does not constitute legal or tax advice, and no attorney client relationship is implied or formed by this article. You should always consult with a tax professional or attorney before taking any action. The information on this website is considered LEGAL ADVERTISING under applicable California law and may be considered advertising under your state’s laws and ethical rules. The responsible member for this advertising is D. Andrew Brown of Essayli & Brown LLP.