Few tax laws cause as much confusion as those that apply to the gift and estate tax, and 2014 is no different. Fortunately, the major changes in recent years have been to your advantage.
Gift taxes for 2014
In good news for you -- and possibly for those who receive your gifts -- the gift tax exclusion has risen in recent years. For 2013 and 2014, you can give up to $14,000 per person before you are required to file a gift tax return.
You may be able to give more than $14,000 to someone without having to file a gift tax return. You can pay someone's medical expenses or tuition directly without counting the amount you pay as a gift. You can give as much as you want to your spouse without having to file a gift tax return. If you're married, you and your spouse can each give a recipient up to $14,000 before you have to file a gift tax return.
And if you do have to file a gift tax return? You probably still won't pay any tax. The amount that your gift exceeds the annual limit is applied to your lifetime gift tax exemption. The exclusion amount in 2014 is $5,340,000.
If you're the recipient of a generous gift, you have even less reason to worry. Except in rare cases -- for example, if the IRS cannot collect required gift taxes from the person who gave you the gift -- you won't have to pay tax on it or report it.
Estate taxes for 2014
With the exemption amount in 2014 at $5,340,000, very few taxpayers have to worry about estate tax.
This has not always been the case. In 1997, the estate tax exemption was only $600,000. As late as 2008, it was still just $2,000,000.
The top estate tax rate has gone down over the years, too. A person dying in 2001 could pay a top estate tax rate of 55%. For 2014, the highest federal tax rate an estate pays is 40%.
As you file gift tax returns during your lifetime, the amount that your gift exceeds the annual limit reduces your lifetime gift tax exemption.
Does this mean I have to pay tax on my estate over $5,340,000?
It shouldn't. If you have an estate greater than $5,340,000, with a little tax planning you can greatly reduce or eliminate your estate tax liability. In fact, most high-wealth estates pay far less than 40% to the federal government.
The simplest way to avoid estate tax is to give your wealth away, especially if you think you can choose charities that could make better use of your money than the federal government would. You can also use the annual gift tax exclusion to distribute your wealth to family members and whomever else you choose while you are still alive.
You can also reduce your potential estate tax burden by making good use of trusts, charitable trusts, and life insurance policies.
Don't forget state inheritance taxes
The federal government isn't the only entity to take notice when large sums of money enter an estate. State governments have their own laws. Your estate may owe state inheritance tax even when there's no federal estate tax with which to contend.
Understanding how the laws work can help you minimize the amount of gift and estate tax that you and your estate pay. You've worked and saved for your money, so take time to make sure it goes where you want it to when you're gone.
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