Under current gift and estate tax law, if you pay a gift or estate tax, it will be at a flat rate of 40%. Forty percent. But most people will never pay that rate, or any rate at all, because their estates are not large enough and what estate or gift taxes they could have to pay, they can pay with coupons.
Now, the IRS doesn’t call them coupons, but coupons they are. Here’s how they work.
Say you and your spouse have four children. Together, you could give each of them $28,000 a year, and you would pay no gift tax on those gifts. That’s because the IRS grants each of you a coupon worth $14,000 each year, a coupon the IRS calls an “annual exclusion.” You can use as many of those $14,000 coupons as you want ($28,000 if done jointly as spouses). Got 10 friends? You’ve got 10 coupons. Got 20? You’ve can give away $280,000 total to them and pay no gift tax.
But what if you want to give your favorite son or daughter $50,000 one year? Surely there’s a tax there, right? Probably not. You see, Uncle Sam has also given each of us a lifetime, but reducing, coupon of $5,450,000 (in 2016; it’s adjusted for inflation each year), a coupon the IRS calls the Applicable Exclusion Amount or AEA. Thus, the math in the example I just described would be $50,000 – $14,000 – $14,000 = $22,000. You could either pay the gift tax on the $22,000 or subtract it from your lifetime coupon: $5,450,000 – $22,000 = $5,428,000 remaining on your lifetime coupon. That is, the AEA reduces each time you have to use some of it to cover gifts in excess of your annual exclusion amounts.
You can use your lifetime coupon while you’re alive or save it all till you die to pay any estate tax you may yet owe. As I said at the beginning, that won’t be much if any for most people because we won’t have estates that large. (And if you’ve been paying attention, you’ll realize that for a married couple, their estate would have to be almost $11,000,000 before they’d have to pay any estate tax under current law.)
There are other coupons as well. A gift to charity? Use an unlimited coupon. A gift to your spouse? Unlimited as well–unless your spouse is not a citizen of the United States, then it’s only $145,000 per year. Pay your children’s education and medical expenses directly–that is directly to the school or hospital–use an unlimited coupon.
Neat, huh? And I haven’t even discussed portability yet. I’ll save that for later.
There’s a misconception out there that if you use a revocable living trust in your estate planning, you avoid probate and save on all those costs associated with probate. Well, maybe and maybe not.
Did you ever try to take advantage of that permission slip a day or two later? You know, as in, “Well, they gave me permission on Friday, it must be okay today”? I’ll bet you tried something like that at least once. I know I did. What was the result?