Over recent weeks, we have been passing along various updated figures that are relevant from an estate planning and elder law perspective. In this post, we are going to answer a question that many people have about the annual gift tax exclusion.
Before we focus on that particular subject, we will provide the appropriate background information, which will include a review of the 2021 estate tax parameters.
The federal estate tax exclusion is a set dollar amount that can be transferred tax-free, and the portion that exceeds the exclusion is potentially subject to taxation. Last year, the exclusion was $11.58 million, and the 2021 inflation adjustment increased this figure to $11.7 million.
We should point out the fact that this exclusion is in place due to a provision contained within the Tax Cuts and Jobs Act that was enacted in 2017. It is going to expire or sunset at the end of 2025.
If this happens and there are no new tax laws passed in the meantime, the exclusion would go down to the 2017 figure of $5.49 million adjusted for inflation in 2026.
However, since the Democrats now control the White House and both chambers of Congress, we will probably see some changes before then.
There is a marital deduction that can be used to transfer unlimited assets to your spouse tax-free, as long as your spouse is an American citizen. The estate tax exclusion is portable, so a surviving spouse can use their deceased spouse’s exclusion.
Federal Gift Tax
The obvious response to the estate tax would be tax-free lifetime gift giving, and this was possible shortly after the estate tax was enacted in 1916. In 1924, a gift tax was enacted, and it was repealed in 1926. It was reenacted in 1932, and it has been in place ever since then.
During the 1970s, the gift tax and estate tax were unified under the tax code, so the $11.7 million exclusion is a unified exclusion. It encompasses your estate and the gifts that you give while you are living.
2021 Annual Gift Tax Exclusion
There is another gift tax exclusion that sits apart from the unified gift and estate tax exclusion that we described above. You can use this separate exemption to give a certain amount to any number of gift recipients every year tax-free.
The annual exclusion was $15,000 in 2020, and people were hoping for an increase have been disappointed, because it will stay the same in 2021. If you are married, you and your spouse can combine your respective exclusions to give up to $30,000 to any number of gift recipients on an annual basis.
If you are exposed to the estate tax, you can use this exclusion to lower your taxable estate as you transfer assets to loved ones tax-free each year. This exclusion is also used to fund certain types of trusts, and it can be utilized to facilitate tax efficient transfers among members of family limited partnerships.
In addition to this exclusion, there is also an educational exclusion. You can pay school tuition for students free of taxation, but the exemption does not apply to books, fees, and living expenses. Of course, you can use your annual exclusion to provide additional support.
There is another exemption that gives you the ability to pay medical bills for others without being taxed for your efforts, and this exclusion applies to the payment of health insurance premiums.
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