As we wind down 2022 and look forward to 2023, there are few changes related to estate planning that will occur in the new year. The following is a summary of those changes.
Annual Gift Exclusion
The annual gift exclusion is the amount that one person can gift to another person with no estate tax implications. In 2023, the annual exclusion will increase from $16,000 to $17,000. This means that a person can gift $17,000 to as many people as they wish without causing a gift tax or a reduction of their federal estate tax exemption. For example, Grandfather gifts $17,000 to each of his three children and seven grandchildren. Grandfather gifted a total of $170,000 without incurring a gift tax or reducing his federal estate tax exemption. The gift can be money, real estate, machinery, ownership in a business entity or just about any other asset.
Federal Estate Tax Exemption
The federal estate tax exemption is the amount of net worth exempt from estate taxes at death. If a person dies with a net worth less than the exemption, no estate tax will be owed. If a person dies with a net worth exceeding the exemption, the amount exceeding the exemption will be subject to a 40% estate tax. In 2023, the exemption will increase from $12.06 million to $12.92 million.
To further explain the estate tax exemption, let’s continue the prior example using 2023 values. Grandfather has a net worth of $13.0 million. If he were to die with this net worth, $80,000 would be subject to estate taxes. However, after he makes gifts to his children and grandchildren, his net worth is now $12.83 million. Grandfather’s net worth is now less than the federal exemption, so if he dies, there will be no estate taxes.
The IRS allows eligible farmers to reduce their estate valuation by valuing farmland at agricultural value rather than fair market value. This reduction in value is non unlimited. In 2023, the IRS will allow a reduction of $1,310,000, an increase from the 2022 limit of $1,230,000. Eligibility requires the decedent, among other things, to have been a farmer with at least 50% of their assets being farm assets and at least 25% of their assets being farmland.
Consider the following example using 2023 values. Bill was a retired farmer and died with a net worth of $14 million. He was eligible for 2032A so his estate was entitled to a $1,310,000 reduction. After applying the section 2032A reduction, Bill’s estate was valued at $12,690,000 which is below the federal estate tax exemption. By applying 2032A, Bill’s estate is able to avoid estate taxes.
It should be noted that applying 2032A to an estate is complicated and should be done with the assistance of legal counsel.
Every few years, the IRS adjusts the annual gift tax exclusion. The IRS recently announced that the gift tax exclusion for 2023 will be increased to $17,000. This means that a taxpayer may gift up to $17,000 to an unlimited number of persons without having to pay gift taxes or reduce their estate tax exemption amount. Because the gift tax exclusion is available to all individuals, married couples can gift up to $34,000 annually.
For example, Mom and Dad want to gift money to Daughter. Mom and Dad can each gift $17,000 to Daughter for a total of $34,000. Daughter is married and Mom and Dad also gift a combined $34,000 to Daughter’s spouse. Daughter has three children, Mom and Dad can gift to each grandchild as well for a total of $102,000.
As the above example shows, it is possible to gift substantial amounts of wealth to others by gifting. Mom and Dad are able to gift $170,000 each year to their family using the gift tax exclusion. None of the gifts will be subject to gift taxes or reduce the estate tax exemption because the gifts are all less than the annual gift exclusion.
Gifts can be made in excess of the annual gift tax exclusion amount. Gifts exceeding the gift tax exclusion will either cause gift taxes to be owed or will cause the person gifting to have their estate tax exemption reduced by the amount of gift exceeding the annual exclusion. The lifetime estate tax exemption for 2023 will be $12.92 million, up almost one million dollars from 2022.
Consider the following example. In 2023, Dad gifts $1,017,000 to Daughter. The annual gift tax exclusion will cause $17,000 to be a free gift with no tax consequences. The remaining $1 million exceeds the annual gift tax exclusion and thus will reduce Dad’s lifetime estate tax exclusion by $1 million. Dad’s estate tax exclusion will be reduced from $12.92 million to $11.92 million.
Gifting can be an effective means of transferring wealth to other family members or friends. Before gifting, be sure to seek advice from tax advisor as to the advantages and disadvantages of gifting. For a thorough discussion of the implications of gifting, see the Gifting Assets Prior to Death bulletin available at farmoffice.osu.edu.
The holiday season stands out as one of the most generous times of year as people give gifts to the people they love. What better way to get into the holiday spirit than to talk about the tax implications of your gifts? There are three shopping weekends left until December 25th, so here are three highlights about the federal gift tax that you should know:
1. The federal gift tax is assessed on the person who gives the gift, not the person who receives the gift.
An individual who gives a gift of cash or assets with a fair market value greater than $15,000 to any one person in a given year will have to report the gift(s) using IRS Form 709 when filing taxes for that year. These forms cannot be filed jointly, so if a married couple gives a gift that is worth more than $30,000 to any one person, both of them must file IRS Form 709 and report half of the value of the gift.
Form 709 requires a few pieces of information about the gift and who receives the gift. It asks for things like a description of the gift, the recipient’s name and address, when it was given, and its value. While documentation or receipts do not have to be submitted with Form 709, filers should keep records for themselves about the gift in case the IRS has questions.
The gift tax rates for 2018 range from 18 to 40 percent. The rates depend upon how much in excess of the $15,000 exclusion the gift is valued. For instance, a gift valued at $20,000 would have no taxes on the first $15,000, but the $5,000 over the $15,000 threshold would be subject to an 18 percent tax. The 40 percent rate applies to gifts valued at $1,015,000, or $1,000,000 over the $15,000 exclusion.
Fortunately for the recipient, the gift does not count as income to the recipient because the gift falls under the gift tax rules instead of the income tax rules.
2. Each individual may give up to $15,000 in gifts to any person per year free of federal gift taxes. Because this rule focuses on the individual giver, a married couple could give up to a combined $30,000 in gifts to any one person tax free.
To illustrate, if Bob and Betty Buckeye have a daughter, Bernice, both Bob and Betty can give Bernice $15,000 worth of gifts in 2018, for a total of $30,000, without having to pay taxes on the gift. If Bernice is married to Brutus, then Bob and Betty could also give a combined $30,000 gift to Brutus; however, that money is Brutus’s. The gift to Brutus cannot be used to hide a gift to Bernice.
Importantly, some gifts are excluded from the gift tax and do not count toward the $15,000 exclusion threshold. These include gifts to a spouse, gifts of tuition paid directly to the college or institution, gifts of medical expenses, gifts to certain exempt organizations like charities, and gifts to certain political organizations.
However, things like forgiving a debt, contributing to a 529 education plan, making an interest-free or below market rate loan, transferring the benefits of an insurance policy, or giving up an annuity in exchange for the creation of a survivor annuity do count as gifts. When these gifts exceed the $15,000 exclusion threshold, they are taxable.
The $15,000 threshold is new for 2018. In 2017, it was only $14,000. The IRS now revises the amount based upon inflation, but is expected only to do so periodically in $1,000 increments.
3. Under the new tax plan passed by Congress and signed by the President in 2017, the higher estate tax threshold has made gift giving less urgent as a tax planning strategy.
Many individuals used the gift exemption as a way to provide for the next generation while also lessening the risk or burden of federal estate taxes. However, the 2017 tax reform doubled the value of an individual estate that is exempt from the estate tax to $11,180,000. A couple may take advantage of that individual exemption, and, with proper planning, shield $22.4 million in assets from the federal estate tax. Unless an estate is likely to reach the applicable threshold, gifts may not be as important of an estate planning tool solely to avoid estate tax consequences.
Long-term planners may want to keep in mind that the new estate tax exemption is set to expire at the end of 2025. If the $11,180,000 exemption is not extended by the end of 2025, the law will revert back to what it was before the 2017 tax reform, thereby returning the estate tax exemption threshold to around $5.5 million.
Disclaimer: While the estate tax changes may have made gifts less relevant as an estate planning tool for some, this certainly does not mean that gifts should be cancelled this year. The OSU Extension Farm Office cannot take responsibility for that. It only means that more families can focus on giving for love, rather than taxes.
For more information on federal gift taxes, contact an accountant or attorney, or visit the Internal Revenue Service’s “Frequently Asked Questions on Gift Taxes” here. For more general information about how taxes affect agriculture, visit the OSU Extension Farm Office Tax Law Library here.