Reducing Estate Taxes with Annual Exclusion Gifting

Subject to new legislation passed under the Biden administration, United States taxpayers pay an estate tax on death to the extent that the value of their estate exceeds $11,700,000 in 2021; the estate tax is a tax on the right to transfer property upon death. It cannot be avoided by making lifetime gifts to heirs because most such gifts reduce this estate tax lifetime exclusion amount. If the lifetime exclusion amount is exhausted, a gift tax applies in lieu of the estate tax.

In general, any gift is taxable, meaning that the gift will either reduce the lifetime exclusion or require the payment of a gift tax by the donor if the donor's lifetime exclusion has been exhausted. However, there are a number of important exceptions to the rule that any gift is taxable. One such exception is the annual exclusion.

"If a taxpayer makes a gift to another person, the gift tax usually does not apply until the value of the gift exceeds the annual exclusion amount for the year." The annual exclusion is indexed for inflation and is $15,000 in 2021. Under current law, every taxpayer can gift up to $15,000 per year to an unlimited number of donees. Married couples can each make an annual exclusion gift from their own property, essentially doubling the annual exclusion amount. To qualify for the annual exclusion, the gift must be of a "present interest" in property, meaning a gift that the donee can access and use immediately.

An annual exclusion gifting plan can remove significant wealth from a taxpayer's estate over time, thus reducing future gift and estate taxes. For example, a couple with three children and nine grandchildren can potentially gift $360,000 ($15,000 x 2 spouses x 12 heirs) to their family every year without even the need to file a gift tax return. However, there is no requirement that the donee be a family member, meaning that the class of potential donees is only limited by the pool of beneficiaries who the donor wishes to benefit. Annual exclusion gifting should be coordinated with other gifting and tax-mitigation planning but is an important estate and gift tax mitigation tool.