taxes are part of the federal system of transfer taxes. In establishing
laws that taxes wealth when it transfers from one person to another, Congress
was reflecting a bias against inherited wealth that probably dates back to
anti-royalty thinking of the American Revolution.
A gift occurs when someone freely and voluntarily transfers property from themselves to another for less than market value. In estate planning terms we typically talk about lifetime gifts to heirs. There can often be tax advantages in making gifts to children or other heirs during your lifetime.
There are two types
of Estate and Gift Tax exclusions to consider. The first is the Annual
Exclusion. The Second is the lifetime tax free limit that the Internal Revenue
Code refers to as the “Unified Credit”. Think of the Annual Exclusion as a
spigot and the Unified Credit as a bucket.
In 2016 the Annual Exclusion is $14,000. This amount is adjusted annually for inflation. You can make gifts to someone up to the Annual Exclusion amount with no tax consequence. I suggest thinking of the spigot because you can make the gift every year as long what comes from the spigot is no greater than $14,000.
Your Unified Credit is a lifetime amount of wealth that you can pass on to others before you are liable for any taxes. In 2016 the amount of the Unified Credit is $5,450,000. Like the Annual Exclusion the Unified Credit is subject to modification each year for inflation. I suggest thinking of the Unified Credit as a bucket because anytime you use a portion of your Unified Credit it is gone and cannot be replaced.
If you make lifetime gifts greater than the amount of the Annual Exclusion the excess is deducted from your Unified Credit. For families whose estates are well below $5.45 million worrying about gifts in excess of the Annual Exclusion is usually unnecessary. But for wealthier families this is an important consideration.
There are two other kinds of gifts that are completely exempt for gift or estate tax considerations. These are gifts of direct payments for education expenses and medical expenses. When you think about it, this exemption makes a lot of sense. We should not bear a tax consequence when we want to provide for our kids’ education. Or, God forbid, the cost of healing medical care.