Transferring assets to heirs requires care and plan to lower gift taxes and estate taxes. This is especially true because the law makers are in the talk to lower the life time gift tax exemption in future. As of 2021, the estate and lifetime gift tax exemption is $11.7 million per individual.
Annual Exclusion for Gifts: Under U.S. law, each individual is permitted to make gifts up to a certain amount per recipient per year, free of gift tax. As of 2021, this annual exclusion amount is $15,000 per recipient or $30,000 per recipient for gifts made jointly by a married couple. It is thus possible to reduce the size of one’s taxable estate gradually, without incurring any gift tax liability. Gifts that exceed these amounts will count against one’s lifetime exemption.
If a taxpayer gifts properties which value is lower than the life time exemption, he/she can refer to the article “Tax Consequences for Gifting Properties – Gift Tax and Income Tax”
Unified Federal Gift and Estate Tax Exemption: This represents the total amount that an individual can gift during their lifetime or bequeath upon their death without incurring federal gift or estate tax. As of 2021, the unified exemption amount is $11.7 million per individual or $23.4 million for a married couple. This provision enables substantial wealth to be transferred tax-free.
Unlimited Marital Deduction: Transfers of assets between spouses, whether made during one’s lifetime or at death, are generally exempt from federal gift and estate tax under the unlimited marital deduction. The assets transferred to the surviving spouse will, however, be included in their taxable estate.
Life Insurance Proceeds: Life insurance can provide liquidity to an estate for the payment of any estate tax and other expenses upon death. Beneficiaries typically do not have to pay income tax on life insurance proceeds. However, if the policy is owned by the decedent, the proceeds will be included in their taxable estate for estate tax purposes. To avoid this, the policy can be structured under an Irrevocable Life Insurance Trust (ILIT), thus excluding the proceeds from the decedent’s taxable estate.
Use of Trusts: Various types of trusts can be established for the management and protection of assets, provision for beneficiaries, and minimization of taxes.
- Bypass Trusts (or AB Trusts or Credit Shelter Trusts): These allow married couples to fully utilize their individual estate tax exemptions. When one spouse dies, a portion of their estate (up to the exemption amount) funds the Bypass Trust. The remainder of the estate transfers to the surviving spouse, exempt from tax under the unlimited marital deduction.
- Irrevocable Life Insurance Trusts (ILITs): These can own a life insurance policy on the life of the grantor. The death benefit from the policy is excluded from the grantor’s estate and can be used to provide estate liquidity or income to beneficiaries.
- Dynasty Trusts: These allow wealth to be passed down across multiple generations while minimizing estate taxes. Dynasty Trust takes advantage of the Generation-Skipping Transfer Tax (GSTT) exemption, which allows assets to pass to skip-person beneficiaries (typically grandchildren or more remote descendants) without incurring additional estate or gift tax. As of 2021, the GSTT exemption amount is the same as the federal estate tax exemption ($11.7 million per individual).
Charitable Donations: Assets donated to qualifying charities are deducted from the taxable estate, reducing its size. Moreover, these charitable contributions can be claimed as deductions on the individual’s income tax return if they itemize deductions.
Family Business Exemptions: Special provisions under the Internal Revenue Code may allow the deferral of estate taxes or the installment payment of such taxes over an extended period for qualified, closely-held family businesses. If a large portion of an estate consists of a family-owned business, the heirs may have the option to defer estate taxes, pay the tax in installments over a period of up to 14 years, or qualify for a special use valuation to decrease the taxable value of the business. However, these options are subject to complex rules and not all businesses qualify.
Limited Partnership is one of important methods to lower gift tax and estate tax for generations.
What is Limited Partnership? ”A California LP may provide limited liability for some partners. There must be at least one general partner that acts as the controlling partner and one limited partner whose liability is normally limited to the amount of control or participation of the limited partner. General partners of an LP have unlimited personal liability for the LP’s debts and obligation”
I will have a separate post on why limited partnership can be used in estate planning as a method to lower potential gift and estate tax burdens
In conclusion, the strategic transfer of assets to heirs while minimizing tax liability is an intricate process that demands careful planning. Techniques such as lifetime gifting, strategic use of federal estate and gift tax exemptions, utilizing trusts, making charitable donations, and employing family business exemptions, when used effectively, can substantially reduce the estate’s tax burden.
References
Starting a Business – Entity Types
https://www.sos.ca.gov/business-programs/business-entities/starting-business/types
Khanh Le, preferred name as Jessica Le, is a licensed Certified Public Accountant (CPA). Jessica also earned a Master of Business Administration (MBA) from San Jose State University.
