Q. My wife and I were wondering how much we could leave to our children free of any gift or estate tax?
A. The answer may surprise you. A married couple can actually transfer to up to $10,980,000 to their children, free of any gift or estate tax (in 2017). You can either do so by either making lifetime gifts, or by leaving it to them as an inheritance. You can actually mix-and-match: you can gift a portion of this exemption amount to them during your lifetimes by way of gifts, and the balance upon death by way of your will or trust.
This comes as a surprise to many couples, who mistakenly believe that they are limited to gifts of $14,000 per year per child. Not so. The $14,000 per year Annual Exclusion Amount (“AEA”) is merely the amount that each of you may gift annually to as many individuals as you wish, without the need to file a gift tax return. If you were so inclined, you and your wife could each make a $14,000 gift to every single person in your neighborhood without the need to file a single gift tax return!
More realistically, married couples typically prefer to leave their assets to each other, first, and then to their children. Under tax laws signed by President Obama in 2010 and 2013, each person has an exemption from the federal estate tax of more than $5 million. This exemption adjusts each year based upon inflation. For an individual dying in 2017, that exemption is now $5,490,000. If a married person dies without using his entire exemption, the unused portion may be timely claimed by his surviving spouse, who thereby preserves it for later use to combine with her own exemption. The deceased spouse’s unused portion is called the Deceased Spouse’s Unused Exclusion Amount (“DSUEA” for short).
This transferability of the DSUEA to the surviving spouse is called “portability”. In essence, the unused portion of the first spouse’s exemption may be “ported”, or transferred, to the surviving spouse, assuming a timely election is made by the survivor.
Example: Bob and Sue have an estate worth $9 million. Bob dies in 2017 and leaves everything to Sue. Everything passes to Sue without tax under the Unlimited Marital Deduction available to transfers between spouses. So Bob’s entire DSUEA is therefore unused. Sue’s CPA helps her make a timely election to claim Bob’s DSUEA by filing a Form 706 Estate Tax Return. For simplicity, assume Sue also dies in 2017 and that her estate is then still worth $9 million. Her estate would then be entitled to all of Bob’s unused DSUEA, plus her own exemption, so she could then leave $5,490,000 + $5,490,000 = $10,980,000 to their children, estate tax free. This plan completely tax shelters the estate passing to their children. Caution: if Sue does not made a timely election to port Bob’s DSUEA, then the excess value of her estate above $5,490,000 would be subject to estate tax, at the very hefty rate of 40%, resulting in an estate tax of over $1.4 million.
By combining your exemptions via a timely election after the first death, you and your wife can minimize, or even eliminate, estate tax for your children. Note: The ability to port over the DSUEA is more complicated if the survivor later remarries, but even then there are planning options available to minimize tax.