Tax Avoidance Planning

The federal gift and estate tax is essentially 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. Federal gift and estate taxes are levied on 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.

Every taxpayer’s estate is subject to federal gift and estate taxes. In addition, a handful of states also impose an estate tax, including the State of Maryland. That means that your estate is also potentially subject to Maryland estate taxes.

An estate tax is a tax imposed on the estate of a deceased individual. An inheritance tax is a tax imposed on an individual when they inherit assets. An estate tax 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 is paid by the beneficiary or heir after those estate assets have been passed down. Maryland also imposes an inheritance tax of between one and ten percent, depending on the beneficiary’s relationship to the decedent.

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. The temporary increase in the lifetime exemption amount presents an opportunity for those with significant taxable assets to transfer more of that wealth without incurring taxes over the next few years.

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 valued at $15 million. If your spouse did not need to use all his/her lifetime exemption, the remainder would “port” over to you. Your estate would then be entitled to use your own exemption as well as what was left of your spouse’s exemption.

The annual exclusion is an extremely beneficial tax avoidance tool that allows each taxpayer to gift up to $16,000 (as of 2022) in assets to an unlimited number of beneficiaries each year tax-free. Couples can gift-split and gift assets valued at up to $32,000. By way of illustration, a married couple with two children could transfer $64,000 in assets each year without using any of their lifetime exemptions.