Each year around this time, the IRS announces new inflation adjusted “numbers” which can increase 401(k) contributions and estate/ gift tax exemptions. Believe it or not, the same distressing “cost of living” increases we’ve experienced buying gas and food, actually bring good news on the tax front.
The US has what’s known as a “unified” estate and gift tax system, which levies a tax on gifts you make while alive and assets you leave when you die, if they exceed the exemption. For 2023, the estate/gift tax exemption is $12,920,000 up from $12,060,000 in 2022. That’s an $860,000 “cost of living” increase!
While the estate tax rate is 40%, few estates actually pay it because of the large exemption, and exemptions for gifts to charities and spouses. For 2019, the IRS reports that only 6,409 estate tax returns were filed, and of them, only 2,570 (40%) owed taxes. These filings generated $13.2 billion in revenue, which is not much when you consider Elon Musk paid $44 billion for twitter. Although the estate tax is not a big revenue generator for the government, serious tax planning may be needed for those in the ballpark.
Married Couples. Married couples can generally make unlimited gifts to each other, in addition to availing themselves of the exemption amount. Under the doctrine of “portability,” one spouse can use the other’s “unused” exemption to shield assets from tax. The tandem use of the exemption and unlimited marital deduction enables families to transfer great wealth, with some important caveats:
Only spouses who are US citizens can receive unlimited assets and exempt gifts. If a recipient spouse is not a US citizen, tax-free gifts are limited to $175,000 for 2023, up from $164,000 in 2022. If gifted assets (or assets inherited from a spouse’s estate) exceed this amount, they will be taxed at 40%, unless they are paid into what’s known as a “qualified domestic trust (QDOT).” Complex tax rules govern these trusts which mandate estate taxes are paid when principal is ultimately paid out of the trust.
While “portability” greatly enables married couples to share $25,840,000 in exemptions, regardless of how assets are titled, this largesse doesn’t extend to NYS estate tax, where how assets are titled is essential to consider, to maximize the use of an available NYS exemption by both spouses.
The annual gift tax exemption is increased to $17,000 for 2023, up from $16,000 in 2022. You can make gifts up to this amount to an unlimited number of people and not file a gift tax return. If a gift exceeds this amount, a gift tax return must be filed, but taxes aren’t actually paid until the exemption amount is used up.
For example, if a mother gives her daughter $300,000 to purchase a home, $17,000 would be covered by the annual gift tax exclusion. A gift tax return reflecting a gift of $283,000 would be filed. If Mom has any of her exemption remaining ($12,920,000 in 2023), no gift tax would be due, but the amount of Mom’s available exemption would be reduced by $283,000.
“Annual exclusion gifts” are a valuable tool to reduce potentially taxable estates. Often wealthy families introduce gifting programs to children and grandchildren to gradually remove assets and appreciation from their estates. This can be especially important for those close to the taxable limit in NYS as well.
New York Estate Tax. The NY estate tax exemption is slated to increase to $6,540,000 for 2023, up from $6,110,000 in 2022. Tax rates on estates graduate to 16%, and the NY estate tax landscape is filled with unfortunate and unique challenges:
NY does not offer “portability”, so spouses must have enough property in their own name to soak up the exemption. For example, if Helen and Harry have combined assets worth $12,000,000, but everything is in Harry’s name, Harry’s estate will pay NYS estate tax and Helen’s won’t. With proper planning, where roughly $6,000,000 of the assets are held in each spouse’s name, the NYS estate tax can be avoided for both estates.
If an estate has taxable assets which are greater than 5% of the exemption amount, the entire estate is subject to tax – not just the amount above the exemption. This is politely called a “cliff” tax. Often the math isn’t done until a person passes away, when property is valued, and this aspect of NY estate tax can be problematic. With proper planning, gifts can be made to charities to zero out the “cliff tax” if a taxpayer’s estate would otherwise be fully taxable.
NY does not subject lifetime gifts to tax, but does “claw back” gifts made within three years of death, into the estate tax calculation.
NY Metro Estate Taxes. Beginning in 2023, the CT estate tax exemption will equal the federal exemption, up from $9,100,000 in 2022. NJ eliminated its estate tax on January 1, 2018, however, it still has an inheritance tax. Gifts to spouses, children and grandchildren are exempt, but gifts to others are not.
Bottom Line. For most Americans, estate tax planning is not an everyday concern. But for high-net-worth individuals, or NYS residents with assets above $6 million, careful planning is essential to reduce taxes. Income taxes also factor in if you are contemplating gifts of highly appreciated property while you are alive.
Contact us today to get estate planning in place for you and your loved ones.
Susan G. Parker is an attorney in Briarcliff Manor, NY. Please contact her at susan@susanparkerlaw.com or (914) 923-1600 to get started today!