One aspect of estate planning involves devising strategies to minimize the amount paid in federal taxes out of one’s estate. At the end of 2017, the total exemption for the federal estate, gift, and generation-skipping transfer (GST) taxes doubled. This increase is currently set to expire after eight years, after which it will revert to pre-2018 levels. This provides taxpayers with a limited window of time to take advantage of the significantly higher exemption amounts. Our Los Angeles tax advisors can help you make use of this opportunity.
What Are the Estate, Gift, and GST Taxes?
The Internal Revenue Code (IRC) defines the estate tax in a rather circular fashion as a tax on “the transfer of the taxable estate of” a decedent. The gift tax is defined in a similar fashion as a tax “on the transfer of property by gift.” A highly-oversimplified definition of GST is a transfer to an individual, known as a “skip person,” who is at least two generations younger than the transferor, such as a grandchild and grandparent. The term “skip person” may also refer to a trust in which all beneficiaries are skip persons.
Tax Exemptions for 2020 and Beyond
The IRC allows for a “unified credit” against the estate tax, which also covers the gift and GST taxes. The tax reform law passed in 2017 amended the IRC to double the unified credit from $5 million to $10 million, with adjustments for inflation. The adjusted unified credit for 2020 is $11,580,000, or $23,160,000 for married couples. Those numbers will likely increase in 2021, and every year after that through 2025. The unified credit amount reverts to $5 million, adjusted for inflation, on January 1, 2026, unless Congress amends the IRC again.
In November 2019, the IRS published an “anti-clawback” rule, which states that transfers made between 2018 and 2025 will be subject to the unified credit amount in place during those years. The IRS will not try to apply the lower unified credit amount if the transferor dies after January 1, 2026.
These are lifetime exemptions. For gift tax purposes each year, the annual exclusion is often more pertinent to taxpayers. The 2020 annual gift tax exclusion is $15,000 for an individual taxpayer, or $30,000 for a married couple.
Other Tax Exemptions
Certain transfers are exempt from the gift tax without numerical limitation. These “qualified transfers,” according to IRC § 2503(e), include tuition payments made directly to an educational institution, and payments for medical care made directly to the provider.
To Trust or Not to Trust?
A taxpayer can provide gifts directly to a recipient, or they can transfer the gift to a trust for the recipient’s benefit. The creation and governance of trusts are generally governed by state law. Federal law only concerns itself with the taxation of transfers into and out of the trust.
The main benefit of transferring a gift directly to a recipient is that it gives the recipient direct and immediate control over the gift. The advantage of a trust is that it shields the gift from the recipient’s creditors, and allows the transferor to have some say over how the gift may be used. It may also allow the transferor to set up the gift within the exemption for GST taxes.
If you need assistance with a tax problem or question in California, the tax advisors at the Enterprise Consultants Group are available to answer your questions and address your concerns. Please contact us online or at (800) 575-9284 today to schedule a consultation to see how we can assist you.