Gift taxes play a significant role in estate planning by influencing how and when assets are transferred to beneficiaries. California, like many states, does not impose a state-level gift tax. However, residents and those transferring assets within the state must still navigate the complexities of federal gift tax regulations and consider other state and federal taxes that can affect asset transfers.
In particular, understanding the relationship between gift taxes and estate planning can help you effectively manage your estate’s size, minimize taxes, and ensure that your wealth is distributed according to your wishes. Here’s how gift taxes affect estate planning.
Federal Gift Tax Basics: What You Should Know
The federal government levies a gift tax on transfers of money or property made from one person to another without adequate compensation in return. The IRS allows individuals to give away a certain amount of money or property to another person each year without having to pay gift tax or even report the gift. For 2024, this annual exclusion amount is $18,000 per recipient. This means you can give up to $18,000 to as many people as you like in a single year without incurring a gift tax.
In addition to the annual exclusion, there’s a lifetime exemption amount that applies to the total of all taxable gifts (those exceeding the annual exclusion) made during your lifetime and the value of your estate at death. The lifetime exemption amount was significantly increased by the Tax Cuts and Jobs Act of 2017 to $11.18 million in 2018 and has been adjusted for inflation since, reaching $13.61 million in 20234 This means that an individual can transfer up to this amount either as gifts during their lifetime or as part of their estate at death, without incurring federal gift or estate taxes.
It’s important to note that the Tax Cuts and Jobs Act increase of the lifetime exemption is set to revert to pre-2018 levels (adjusted for inflation) after 2025, barring further legislative action. This means that the exemption will fall to approximately $7 million. If you have already exceeded that amount, any future gifts above the annual limit will be taxed at a rate between 18% and 40%. This is the case for any amount you want to pass on to your heirs through your estate, as well.
In addition, for gifts or bequests to individuals two or more generations below the donor (e.g., grandchildren), the GST tax may apply in addition to other taxes. Proper planning can help manage GST tax implications, often through the use of trusts.
Minimizing Tax Burdens for Beneficiaries
Minimizing the tax burden for beneficiaries in estate planning involves a combination of legal strategies, financial planning, and timely gifting. Here are several approaches that you can consider to ensure your estate is passed on to your beneficiaries with minimal tax implications:
1. Lifetime Gifting
You can gift up to the annual exclusion amount to as many people as you like each year. This reduces your assets without incurring gift tax or using your lifetime exemption. Similarly, you can pay for loved ones’ education or medical expenses. Payments made directly to a medical institution for someone’s medical care or to an educational institution for tuition (not including books, supplies, or living expenses) do not count towards the annual gift exclusion or the lifetime gift exemption. This practice allows for strategic gifting without impacting your ability to make other tax-free gifts.
2. Trusts
While not directly reducing taxes, a revocable trust can help avoid probate, potentially saving time and money and keeping estate matters private. Meanwhile, assets transferred into an irrevocable trust are removed from your estate, potentially reducing taxes. Types of irrevocable trusts include life insurance trusts, bypass trusts, and charitable trusts.
3. Charitable Giving
Leaving part of your assets to charity can reduce the size of your estate and, consequently, any tax liability. Charitable remainder trusts (CRTs) and charitable lead trusts (CLTs) can provide tax benefits while supporting philanthropic causes.
4. Family Limited Partnerships or LLCs
Family limited partnerships (FLPs) or family limited liability companies (LLCs) can be used to manage and control family assets while providing tax advantages through valuation discounts for lack of marketability and minority ownership.
5. Life Insurance
Proceeds from life insurance are typically not taxable to beneficiaries. Owning the policy in an irrevocable life insurance trust can remove it from your estate, avoiding taxes on the proceeds.
6. Business Succession Planning
For business owners, transferring business interests to heirs over time, especially using valuation discounts, can reduce estate taxes while ensuring the continuity of the business.
7. Estate Freezing Techniques
Techniques like selling assets to a grantor trust in exchange for a promissory note can freeze the value of your estate, allowing future appreciation to occur outside of your estate and reduce taxes.
Ensure Your Plan Accounts for Gift Taxes
While California residents do not face state gift taxes, federal rules, and other tax considerations make understanding gift and estate planning vital. Effective use of annual exclusions, lifetime exemptions, and strategic planning with trusts can help minimize the overall tax impact of transferring assets. Always consider professional advice to navigate these complex areas effectively and ensure that your assets are transferred in the most tax-efficient manner possible.At the Law Offices of Denise Eaton May, P.C., we can help you craft an estate plan that accounts for all of these concerns and more. Our skilled attorneys have decades of experience working within California and federal laws to create plans that suit individual clients’ needs and preferences. We encourage you to schedule your consultation today to learn more about how we can help you minimize the impact of gift taxes on your estate and beneficiaries.
