For 2015 you can leave bequests/gifts to other individuals upon your death–worth up to $5.43 million free of any federal estate tax. This is the so-called estate-tax exemption. If you’re married, both you and your spouse are entitled to separate $5.43 million exemptions. If one spouse dies and does not use up his or her full exemption, the leftover exemption amount can be left to the surviving spouse.
The gift-tax exemption
You can also give away a cumulative total of up to $5.43 million to relatives, friends, whomever during your life without owing any federal gift tax. This is the so-called gift-tax exemption. If you’re married, both you and your spouse are entitled to separate $5.43 million gift-tax exemptions.
Gifts made under the $14,000 annual gift-tax exclusion rule to any one person will not trigger any federal gift taxes, nor will they reduce your federal gift-tax or estate-tax exemptions. However, gifts in excess of the annual $14,000 “freebie” to one person will reduce both exemptions dollar for dollar. Only if you’re so generous during your lifetime that you completely burn through your $5.43 million gift-tax exemption, will you have to start paying federal gift tax. Even then, the tax only hits gifts in excess of the $14,000 figure.
Bottom line: Relatively few people will ever reach the point of actually owing any federal gift tax.
The $14,000 annual gift-tax exclusion
For those with large estates, the $5.43 million estate-tax exemption isn’t enough. That’s where the $14,000 annual gift-tax exclusion rule can help.
The benefit of making gifts up to the exclusion amount: They reduce your taxable estate, and they shift any taxable income generated by the gifted money to your kids, who are probably taxed at a lower rate than you. This $14,000-a-year strategy works particularly well for those who wait until late in life to start serious estate planning.
Let’s say, for instance, you and your spouse have an estate worth about $15 million. If you both die tomorrow, the federal estate-tax bill could be about $1.66 million. Say you have two adult children (both married) and four grandchildren. You and your spouse could together give away $224,000 a year ($14,000 from each of you to both children, their spouses and four grandkids) and cut that looming estate-tax bill significantly in just a few years. That’s because gifts under the $14,000 annual gift tax exclusion rule don’t cut into your $5.43 million gift-tax or estate-tax exemptions, but they chip away at your taxable estate. So your estate tax exposure can gradually be reduced by taking full advantage of the annual gift exclusion deal.