The Estate Tax and Lifetime Gifting

Key Points

  • Spreading gifts throughout your lifetime is a great strategy to help reduce estate taxes. Just be sure to leave yourself enough to live on.
  • Gifting up to $14,000 per recipient per year and making direct payments to medical and educational providers on behalf of loved ones are good options for minimizing taxes.
  • Any exemption you use for gifting will reduce the amount you can use for the estate tax.

As a general rule, it's better to give money to your loved ones while you’re still alive than to wait until after you pass away. There are numerous ways to give money gift-tax free—and even if your gift is taxable, at least the recipient will be able to enjoy the gift's full value while you cover the taxes. In contrast, if your estate is subject to the estate tax, those taxes will come directly out of what your loved ones would otherwise inherit.

Picture four quarters on the table in front of you. If you were to die with all four quarters and were in the 50% estate tax bracket (the current top rate is 40%, so 50% is not unimaginable), your heirs would be left with two quarters. The federal government would get the other two.1

That's the estate tax in action.

Now imagine a different scenario. You start with four quarters and move two of those quarters, representing a lifetime gift to your loved ones, aside. Now, of the remaining two quarters, another is set to the side of the table as the gift tax you would owe.1 And in this case, your beneficiaries would have as much as they did in the first scenario, and you would still have a quarter left.

Gifting provides a couple of added bonuses. Any future appreciation on the gift is in the hands of the beneficiary and outside your estate. Plus, you get to participate in the enjoyment of the gift while you're still around.

Below are the rate and exemption levels for gift and estate taxes in 2017:

Unified estate and gift tax exemption for 2017

Highest rate Exemption
40% $5.49 million*

How the gift tax works

Currently, you can give up to $14,000 each to any number of persons in a single year without incurring a taxable gift ($28,000 for spouses "splitting" gifts). The lucky recipient typically owes no taxes and doesn't have to report the gift unless it comes from a foreign source.

You can also make unlimited payments directly to medical providers or educational institutions on behalf of others for qualified expenses without incurring a taxable gift.

However, if your gift exceeds $14,000 to any person during the course of the year, you‘re to report it on a Gift Tax Return (IRS Form 709). Spouses splitting gifts must always file Form 709, even when no taxable gift is incurred.

For taxable gifts, each donor has an aggregate lifetime exemption before any out-of-pocket gift tax is due. In other words, under current law you can give away up to $5.49 million2 during your lifetime—over and above the annual $14,000 exclusion and any payments made directly to educational or medical providers on someone else's behalf—and still avoid gift tax.

There's one big caveat here. The $5.49 million2 exemption applies to gift and estate taxes combined—whatever exemption you use for gifting will reduce the amount you can use for the estate tax. (This is what the IRS refers to as a "unified credit.") That said, surviving spouses may claim any unused exemption from the deceased spouse.

Example 1: You're unmarried and give away $3 million (over the $14,000 per person annual exclusion) during your lifetime. After you die, $2.49 million of your estate is still exempted from the estate tax.2

Example 2: Your spouse gives away $4 million and you give away $1 million (over the $14,000 per person annual exclusion) during your lifetimes. If one of you passes away, the surviving spouse will have a $5.98 million estate tax exemption ($1.49 million of unused exemption from your spouse plus $4.49 million of your unused exemption).2

Lifetime gifting and estate planning

Taking advantage of the annual $14,000 exclusion and making payments directly to medical or educational providers on behalf of loved ones is a great strategy that helps preserve your lifetime exemption.

Most advanced wealth-transfer strategies minimize gift taxes by taking advantage of the annual exclusion, the lifetime exemption and valuation discounts available under the law (a valuation discount means the gift is worth less than its apparent value for gift tax purposes).

Finally, a couple of caveats:

  • Lifetime gifting can be a great strategy, as long as you leave yourself enough to live on. For the gift to count, it has to be a complete and irrevocable transfer. Be sure to plan carefully with the help of a professional.
  • If the estate tax is ever repealed (as it briefly was for the 2010 tax year), you may regret having paid gift tax now in an effort to minimize your estate tax. You have to do the best you can, based on what you know now, within the context of your goals.

I hope this enhanced your understanding of the estate tax and lifetime gifting. I welcome your feedback—clicking on the thumbs up or thumbs down icons at the bottom of the page will allow you to contribute your thoughts. (If you are logged into Schwab.com, you can include comments in the Editor’s Feedback box.)

Next Steps

Talk to Us
To discuss how this article might affect your investment decisions:
-          Call Schwab anytime at 877-338-0192.
-          Talk to a Schwab Financial Consultant at your local branch.

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Important Disclosures