Estate and Gift Tax: Essential Considerations

Logan Baker, JD, LL.M., MBA

Lead, Senior Wealth Strategist

Summary

Unlock strategies to navigate estate and gift taxes effectively, help minimize tax burdens, and outline specific financial objectives.

Estate and Gift Tax: Essential Considerations Image

It is easy to be overwhelmed by the maze of estate and gift tax information out there. Fear not! The advisors, estate planning, and tax professionals at Mercer Advisors can help demystify the complexities of federal estate and gift taxes. To start, we’ve compiled several of the nuances you may encounter, with the goal of helping you navigate these issues with ease.

Unlocking the dynamics of federal estate and gift taxes: What you need to know

In the realm of federal estate and gift taxes, the spotlight often falls on the donor or decedent, rather than the recipient. Why? Because typically, the recipient isn’t responsible for federal estate or gift tax payments, regardless of the gift’s size or timing. Instead, it’s the donor or the decedent’s estate that bears the tax burden and reporting obligations.

These taxes, enshrined in Subtitle B of the Internal Revenue Code (IRC) represent two sides of the same coin, intricately linked yet often misunderstood. Sharing a common lifetime exemption ($13.6 million for 2024) and tax rates, they are more intertwined than meets the eye.

Consider the parallels: transfers between spouses, for instance, are exempt from taxation, whether during one’s lifetime or at death, thanks to the IRC provisions. The transfer from one spouse to another is a gift, but it’s a gift that’s fully deductible for gift tax purposes. Similarly, a decedent can leave an unlimited amount to their spouse at death without the transfer being subject to estate tax.[i] This is known as the estate tax unlimited marital deduction.[ii]

Here’s another similarity. If someone passes away with a total net worth above the estate tax threshold, their executor must file an estate tax return (Form 706) and pay an estate tax bill at a tax rate of 40% on the excess amount. What’s perhaps less well-known is that lifetime gifts above that same threshold will require the donor of the gift to file a gift tax return (Form 709) and pay a gift tax bill at that same 40% rate on the excess amount.

Designed to complement each other, estate and gift taxes operate in tandem, with strategies benefiting one often impacting the other. Picture this: an individual with a $30 million estate opts to gift their entire wealth to their children to evade estate tax. While their estate tax liability vanishes, the lifetime transfer triggers a hefty gift tax bill at the same 40% rate, payable immediately.

Understanding this intricate relationship is pivotal in developing a comprehensive plan to help minimize the combined tax burden.

Navigating estate tax thresholds: Understanding the impact on tax liability

In 2024, if a taxpayer’s estate is valued at $13.6 million or less upon their passing, no estate tax is owed. However, for estates exceeding this threshold, only the excess is taxed at a rate of 40%. For instance, if a decedent’s estate is valued at $14.6 million, the estate owes tax on the $1 million exceeding the exemption.

Now let’s delve into the lifetime exemption amount regarding the gift tax. Had the same taxpayer gifted their $14.6 million estate while alive in 2024, they would face 40% gift tax on the same $1 million. Whether transferred during life or at death, only the portion exceeding the exemption is taxable.

While estate and gift taxes are essentially the same tax applied at different times (the gift tax during life and the estate tax at death), they operate independently and are subject to different rules. In our example, the $1 million exceeding the lifetime exemption would be subject to either gift tax if transferred during life or estate tax if transferred at death — but never both. Understanding these dynamics is key to strategic tax planning.

Maximizing benefits with the gift tax annual exclusion limit

The gift tax annual exclusion limit is a crucial figure that operates independently from estate tax rules yet plays a vital role in long-term financial planning. This limit denotes the maximum amount an individual can gift annually to another person without incurring gift tax liabilities and without filing a gift tax return.

Like the lifetime exemption amount, the annual exclusion limit is adjusted for inflation, typically increasing by $1,000 every one to three years. As of 2024, the limit stands at $18,000.

Annual exclusion gifts hold significant advantages — they are not only exempt from taxation but also exempt from reporting requirements. For instance, a $1 million gift falls within the $13.6 million lifetime exemption, rendering it tax-free but necessitating reporting on a gift tax return and impacting the donor’s lifetime exemption. Conversely, gifts within the $18,000 annual exclusion limit require no reporting and do not diminish the donor’s lifetime exemption.

Leveraging portability: Optimizing lifetime exemption strategies

The lifetime exemption amount applies individually, granting each taxpayer a $13.6 million exemption. Estate tax laws enacted in 2011 enable married couples to combine their exemptions through “portability.” This allows the surviving spouse to inherit the deceased spouse’s unused exemption, known as the DSUE. For instance, if one spouse dies in 2024 without using their exemption, their DSUE of $13.6 million can transfer to the surviving spouse, doubling their lifetime exemption to $27.2 million.

If married, you should consider portability rules and their strategic implications. While preserving the maximum portability amount for the surviving spouse may be advantageous in some scenarios, others might benefit from utilizing or “burning” some or all of the deceased spouse’s exemption. An estate planning professional can help determine which option is best for your specific situation.

Estate tax sunset: Strategic planning in uncertain times

With the estate tax sunset on the horizon, strategic planning takes center stage. As the available exemption amount is set to decrease, taxpayers face a “use it or lose it” scenario concerning gifts. For instance, if the 2026 exemption amount is reduced to $7 million, that becomes the maximum gift limit without triggering gift tax liabilities from January 1 of that year forward. While the post-sunset exemption amount remains uncertain pending inflation adjustments, projections hover between $6 million to $7 million.

If someone wants to give less than the post-sunset exemption amount, they would still be able to. However, it’s essential to factor in any taxable gifts already made, as they diminish the available exemption amount.

The bottom line

For individuals and families grappling with federal estate and gift tax concerns, strategic planning by knowledgeable legal, tax, and financial advisors is often crucial to help minimize the overall tax impact. With anticipated changes in 2026 and given the complexity of many tax strategies which demand thorough consideration and implementation lead time, we recommend starting the conversation with your trusted advisor now.

 

1 The U.S. Code contains all federal laws and is organized into 54 titles and five appendices. Title 50a is War and National Defense, Title 23 is Highways, Title 7 is Agriculture, Title 39 is the Postal Service, and so on. The Internal Revenue Code is Title 26. Within Title 26, most taxes are described in Subtitle A (Income Taxes) and Subtitle B (Estate and Gift Taxes). Nine other Subtitles address other tax matters such as excise taxes, procedure and administration, the Joint Committee on Taxation, etc. An easy to navigate online version of the U.S. Code is available here.

2 IRC § 2523(a). The deduction is limited to $185,000 annually (as of 2024) if the recipient spouse is not a U.S. citizen.

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Mercer Advisors is not a law firm and does not provide legal advice to clients. All estate planning document preparation and other legal advice is provided through select third parties unrelated to Mercer Advisors. Tax preparation and tax filing are a separate fee from our investment management and planning services.

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