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Money IQ: 2013 Estate Tax and Annual Gift Tax Exemption Limits

on January 23, 2013 - 12:19pm
Money IQ
By Dara L. McKinney

2013 Estate Tax and Annual Gift Tax Exemption Limits

Although Congress temporarily avoided the “fiscal cliff”, the American Taxpayer Relief Act of 2012 (“Act”), enacted Jan. 2, 2013, made some permanent changes with respect to the lifetime estate and gift tax exemptions that may affect your estate plan.

This column outlines two key changes and also discusses how the annual gift tax exemption may be used as an estate planning tool.

Lifetime Estate and Gift Tax Exemptions: 

Legislators permanently approved the lifetime estate and gift tax exemption (also referred to as estate and gift tax exclusion) which was $5.12 million in 2012, with annual adjustments for inflation. 

The IRS recently announced an inflation adjustment for 2013 whereby the lifetime estate and gift tax exemption this yearis $5.25 million. 

What this means is that if you were to die this year that you can pass on a total of $5.25 million free of estate tax. 

None of this affects the rule that spouses can pass on unlimited amounts to each other without estate tax consequences at the time of the first spouse’s death.

The unification of the estate and gift tax exemption is also permanent. Therefore, in 2013 each person can make lifetime gifts of up to $5.25 million without paying gift tax. 

Any such gifts would reduce the estate tax exemption available to that person when he or she dies. 

Annual Gift Tax Exemption:

The annual gift tax exemption (also known as the annual gift tax exclusion) increased to $14,000, per person, for 2013 ($28,000 for married couples.) This means that a person can give to another person the total amount of $14,000 in 2013 without having to pay any gift tax or fulfill any special reporting requirements to the IRS. 

Any amount you give on an annual basis at or below the annual gift tax exemption also does not apply to nor affect your lifetime gift tax exemption. Using the maximum annual gift tax exemption, or a lesser amount, is a tool that allows you to give to your heirs now rather than wait until you have passed away. 

It is also a tool that you may use to lower your estate tax liability if your total assets are more than $5.25 million (or such future applicable estate tax exemption amount.)

For example, Sarah is a widow and has approximately $6 million in assets and receives good monthly income from lab retirement and Social Security. When her husband, Tom, passed away a few years ago, they had not done any estate tax planning so Sarah inherited everything outright. 

Although the amount of $5.25 million is currently free from estate taxes, should Sarah die this year the concern is with the estate tax rate increase to the maximum amount of 40 percent.  This means that without any further planning on Sarah’s part, the difference between the value of her actual estate and the estate tax exemption at the time of her death will be taxable and the tax rate is potentially high based on the final amount being taxed. 

Sarah has ample income to take care of her living expenses, and to otherwise enjoy the fruits of her and Tom’s labors. Rather than wait until she dies to share the wealth with her family, Sarah has decided to begin an annual gifting program to her two adult children and her six grandchildren. 

This means that for 2013 she can gift to each of them up to the amount of $14,000. This allows Sarah to gift a total of $112,000 from her estate now. If she continues to practice annual gifting at this same rate, she will effectively lower the value of her estate within approximately six to seven years so that it is at or lower than the estate tax exemption. 

If Sarah increases the number of persons she includes in her gifting (e.g. her children’s spouses), then she lowers the value of her estate that much faster and will possibly avoid estate taxes upon her death. This is only one example of how using the annual gift tax exemption can become a part of your estate plan. It is also important to note that you can gift to any individual—it does not have to be a family member or even an adult. 

The permanent increase in the estate tax exemption, including the unification with the lifetime gift tax exemption, will certainly affect people’s estate planning strategies. More importantly, estate planning attorneys will be better able to advise their clients now that the lifetime estate and gift tax exemption amounts are permanent.

Given these changes, it is a good time to consider reviewing your own estate planning documents and decide if you should meet with your estate planning attorney to discuss revisions.

Editor's note: Dara L. McKinney is a Trust Officer at Los Alamos National Bank. She has worked at LANB since January 2009

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