Do Unified Credit Gift Tax Exclusions Work?

Most  people know they pay taxes on earnings and when money grows. However, there are also estate taxes when money or other assets are given away or passed to another after death. The federal unified tax credit is central to estate planning, says a recent article titled “What Are The Unified Credit’s Gift Tax Exclusions?” from yahoo!.

First, what is the federal Unified Tax Credit? Sometimes called the “unified transfer tax,” the federal unified tax credit combines two separate lifetime tax exemptions. The first is the gift tax exclusion, which concerns assets given to other individuals during your lifetime. The other is the estate tax exemption, which is the value of an estate not subject to taxes when it is inherited. Your estate or heirs will only pay taxes on the portion of assets exceeding this threshold.

The federal unified tax credit is an exemption applied both to taxable gifts given during your lifetime and the estate you plan to leave to others.

If you would rather gift with warm hands while living, you can pull from this federal unified credit and avoid paying additional taxes on monetary gifts in the year you gave them. However, if you’d rather keep your assets and distribute them after death, you can save the unified credit for after death. You can also use the federal unified tax credit to do a little of both.

The federal unified tax credit changes regularly, depending on estate and gift tax regulations. The gift and estate tax exemptions doubled in 2017, so the unified credit right now sits at $12.06 million per person in 2022. This will expire at the end of 2025, when credits will drop down to lower levels, unless new legislation passes.

Up to 2025, a married couple can give away as much as $24.12 million without having to pay additional federal taxes. The recipient of this generous gift would not have to pay additional taxes either. If you consider the rate of  federal estate taxes—40%—optimizing this federal unified tax credit means a lot more money stays in your loved one’s pockets.

How does it work? Let’s say you have four children and each one is going to receive a taxable gift of $500,000. You can pull from your unified tax credit the same year you give these gifts. This way, there’s no need for you to pay gift taxes on the $2 million.

However, this generosity will reduce your lifetime unified credit from $12.06 million to $10.06 million. If you die and leave an estate worth $11.5 million, your heirs will need to pay estate taxes on the $1.44 million difference.

At current estate tax rates, roughly $700,000 would go to the IRS, or more, depending upon your state!

The unified tax credit doesn’t take into account or apply to annual gift exclusions. These annual exclusions allow you to give away even more money during your lifetime and it doesn’t count against your unified limit. As of 2022, taxpayers may give $16,000 per year to any individual as a tax-exempt gift. You can give $16,000 to as many people as you wish each year without being subject to gift taxes. This is a simple way to gift with warm hands without paying gift taxes or reducing the unified limit. The annual gift is per person, so if you are married, you and your spouse may give, $32,000 per year to as many people as you want and the gift is excluded.

Massachusetts Plays by Different Rules. The Massachusetts’ estate tax threshold is only $1 million dollars and Massachusetts does not have a gift tax. So, it’s simple to avoid Massachusetts estate tax by gifting any funds over $1 million, right? Not exactly. You really didn’t think Massachusetts would let you get away that easy, did you?

You are free to gift as much as you wish during your lifetime and not pay any Massachusetts gift taxes, but there is a string attached to those gifts when calculating potential Massachusetts estate taxes. The Massachusetts estate tax is not calculated on a decedents gross estate valued as of date of death, rather, Massachusetts gets you by imposing an estate tax on what they call a “Filing Threshold”.  The “Filing Threshold” is combination of the decedent’s gross estate values as of date of death and any adjusted federal taxable gifts made by the decedent over his or her lifetime. Adjusted federal taxable gifts are those gifts that exceed the federal annual exclusion ($16,000 in 2022 and $17,000 in 2023). All lifetime federal taxable gifts, even if those gifts exceeding the federal annual exclusion amount that avoided federal gift taxes by the application of the federal gift/estate tax exemption ($12.06 million), are added back to a decedent’s gross estate when calculating Massachusetts estate tax. If the sum of the “Filing Threshold” exceeds $1 million, the decedents estate must file a Massachusetts estate tax return on the gross estate valued as of date of death.

Example:

Mrs. Smith’s gross estate at her death totaled $700,00. Her estate consisted of a $565,000 home; and $135,000 in investments, such as bank accounts, brokerage accounts and retirement accounts.

Mrs. Smith’s lifetime taxable gifts totaled $400,000, including sizable gifts made several years ago to her children from her late husband’s life insurance policy proceeds.

Mrs. Smith’s Massachusetts estate tax “Filing Threshold” is the sum of her gross estate at her death of $700,000 and her total lifetime taxable gifts of $400,000 for a total “Filing Threshold” of $1,100,000.

Wait, before you get to upset, understand that Massachusetts does not impose an estate tax on the “Filing Threshold” total of $1,100,000, rather, the fact that the “Filing Threshold” total exceeds $1 million triggers the Massachusetts estate tax on her gross estate at her death of $700,000.   Mrs. Smith’s total Massachusetts Estate Tax is roughly $20,880.

If not for the addition of lifetime taxable gifts of $400,000 to Mrs. Smith’s “Filing Threshold”, her estate would not have exceeded $1 Million, and no estate tax would have been due. Yes, Massachusetts doesn’t have a gift tax, but the way Massachusetts calculates an estate’s “Filing Threshold” resulted in a 5.22% Massachusetts tax on Mrs. Smith’s $400,000 lifetime gifts.

Taxable gifts exceeding the annual gift exclusion amount must be properly documented and should be done in concert with your overall estate plan. They offer great tax advantages, and perhaps more importantly, provide the giver with the joy of seeing their wealth translate into a better life for their loved ones.

Book a Call with attorney John A. Laine today.

Reference: yahoo! (Nov. 18, 2022) “What Are The Unified Credit’s Gift Tax Exclusions?”