Tax Planning in Your Estate Plan – Frequently Asked Questions

The federal gift and estate tax operates as a tax on the transfer of wealth. Every estate is potentially subject to the federal gift and estate tax; however, every taxpayer is also entitled to an exemption before taxes are levied. Federal gift and estate taxes apply to the combined total of the value of all gifts made during a taxpayer’s lifetime and the value of all assets owned by the taxpayer at the time of death. Although the federal gift and estate tax rate fluctuated historically, the American Taxpayer Relief Act of 2012 (ATRA) permanently set the rate at 40 percent.

While every taxpayer’s estate is subject to federal gift and estate taxes, a handful of states also impose an estate tax. California does not impose a state level estate tax as of 2021. If you own property in another state, however, you would be wise to find out if that state imposes a state level estate tax because your property in that state could be subject to the tax. In addition, the existence of a state level tax on estates is something that can change so be sure to consult with an estate planning attorney before assuming no tax will be levied on your estate.

An estate tax is a tax imposed on the estate while an inheritance tax is a tax imposed on an individual when they inherit assets. As such, estate taxes must be calculated and paid by the estate using estate assets prior to any assets being passed down to beneficiaries or heirs. An inheritance tax, on the other hand, is paid by the beneficiary or heir after those estate assets have been passed down. As of 2021, California does not collect an inheritance tax on inherited assets.

Each taxpayer is entitled to make use of the lifetime exemption to reduce the amount of gift and estate taxes owed by their estate. ATRA set the lifetime exemption amount at $5 million, to be adjusted for inflation each year; however, President Trump signed tax legislation into law that significantly increased the lifetime exemption amount for 2018 and for several years to come. These exemption amounts are scheduled to increase with inflation each year until 2025. On January 1, 2026, the exemption amounts are scheduled to revert to the 2017 levels, adjusted for inflation.

Portability refers to a surviving spouse’s ability to use any unused portion of a deceased spouse’s lifetime exemption. For example, imagine that you are married, and your spouse passes away leaving behind an estate (including lifetime gifts) valued at $9 million which is less than the current lifetime exemption limit. Because your spouse did not use all his/her lifetime exemption, the remainder would “port” over to you. You could then use that remainder, along with your own lifetime exemption, when your estate is probated.

The annual exclusion is an extremely beneficial tax avoidance tool that allows each taxpayer to gift up to $15,000 in assets to an unlimited number of beneficiaries each year tax-free. Couples can gift-split and gift assets valued at up to $30,000. By way of illustration, a married couple with two children and four grandchildren could transfer $180,000 in assets each year without using any of their lifetime exemption.