The Gift of Tax Savings

Taxpayers have a valuable opportunity to pursue tax savings through the strategic use of federal gift exemptions. Many taxpayers overlook the potential for significant tax savings through the annual gift tax exclusion. By understanding and effectively utilizing this exemption, even small gifts can add up to substantial financial benefits over time, especially when considered as part of a long-term estate planning strategy.

The federal gift tax exclusion allows individuals to give away a certain amount of money each year to any number of recipients without incurring gift taxes or affecting their lifetime gift and estate tax exemption. As of 2024, the annual exclusion amount is $18,000 per recipient. Married couples can combine their exclusions, allowing them to gift up to $36,000 per recipient each year.

While $18,000 may seem modest in the context of estate planning, the true power of the annual gift tax exclusion lies in its cumulative effect over time. Consistently making annual gifts can significantly reduce the size of a taxable estate, thereby minimizing estate taxes that might be owed upon the donor's death. Here’s how small, regular gifts can lead to big results:

By transferring assets out of their estate annually, individuals can reduce the value of their estate, potentially saving significant amounts in estate taxes. For example, if a married couple gifts $36,000 to each of their three children annually, they can remove $108,000 from their estate every year. Over a decade, this adds up to $1.08 million, excluding any growth on the gifted assets.

Gifts made early in the process have more time to potentially appreciate in value. By transferring appreciating assets, such as stocks or real estate, the future growth occurs outside the donor’s taxable estate. This can lead to substantial tax savings, as the appreciation on the gifted assets will not be subject to estate taxes.

Regular gifting not only offers tax benefits but also provides financial support to family members or other recipients. These gifts can assist with education expenses, home purchases, or other significant life events, reducing the financial burden on the recipients.

For example, consider John and Mary, a couple with three children and four grandchildren. Each year, they gift the maximum annual exclusion amount of $36,000 to each child and grandchild. This totals $252,000 annually. Over 20 years, they would have gifted $5.04 million, without incurring any gift tax or using any of their federal tax exemption, significantly reducing their estate’s taxable value. If the assets gifted appreciate at an average annual rate of 5%, the value of the gifts could grow substantially, further amplifying the tax savings.

 

While the current annual exclusion amount provides a robust opportunity for tax savings, it’s important to remember that the levels are not permanent. These provisions, which are part of the Tax Cuts and Job Act (TCJA) sunset on December 31, 2025; after this date, they fall back to pre-TCJA levels, which when adjusted to inflation are about $7 million per person. Adjustments to the annual exclusion amount or overall tax policy changes can impact long-term planning. Engaging with a tax professional or estate planner is crucial to adapt strategies to evolving laws and ensure the most effective use of gift exemptions.