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The 2018 Estate Tax Rules, and Why They May Not Matter

By Matthew Frankel, CFP® - Oct 29, 2017 at 8:17AM

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The estate tax lifetime exemption and annual exclusion amounts are set to rise in 2018.

The IRS recently announced the 2018 estate tax exemption and annual gift exclusion amounts, and both are rising. This means that high-net-worth individuals can shelter more of their assets from the 40% estate tax this year. However, there's a realistic possibility that the 2018 estate tax rules could end up being irrelevant.

The 2018 estate tax exemption

The estate tax is meant to levy a tax on wealthy Americans who transfer money and property to their heirs. For this reason, there is a certain value of assets per person that can be excluded from the estate tax calculation each year.

A wealth preservation and estate planning folder with a pen on top of it.

Image source: Getty Images.

For 2018, the estate tax exemption is $5.6 million per individual, a $110,000 increase over the $5.49 million 2017 exemption. Since this exemption is per person, married couples can exclude twice this amount, or $11.2 million.

It's also important to mention that the estate tax exemption amount doesn't just pertain to money and property that passes to your heirs after you die. It also includes taxable gifts.

The annual gift exclusion

As I just mentioned, when a wealthy individual gives a gift, it is considered toward that individual's estate tax exemption.

And just like the estate tax exemption, there is a certain amount that can be excluded from consideration for taxation. For 2018, the annual gift exclusion is increasing for the first time since 2013 to $15,000 (previously $14,000). This means that wealthy individuals can give away up to $15,000 in 2018 without affecting their estate tax exemption.

This limit is per recipient. In other words, individuals can give as many $15,000 tax-free gifts as they want in 2018. So, if a wealthy individual has three children and seven grandchildren, they could give away as much as $150,000 of their wealth to those recipients, which will be excluded from their taxable estate. Married couples get an annual gift exclusion for each spouse, which means that a married couple could give tax-free gifts of as much as $30,000 in 2018 to whomever they choose.

Taking advantage of the annual gift exclusion every year can be an effective strategy to avoid estate taxes. The taxable portion of an estate is effectively taxed at a 40% rate, so if the annual gift exclusion is used by an individual to give away $1 million over a series of years, it could potentially save this individual's heirs $400,000 in estate taxes.

Gifts in excess of $15,000 in a given year are taxable for estate tax purposes, and will reduce the giver's exemption once they pass their assets to heirs. For example, if a certain individual gives a total of $115,000 to their child in 2018, their estate tax exemption will be lowered from $5.6 million to $5.5 million as a result.

Why it may not matter

President Donald Trump and congressional Republicans are hoping to pass a tax reform bill later this year. The GOP's tax framework calls for a complete repeal of the estate tax, something Republicans have been trying to accomplish for decades.

The idea of abolishing the estate tax isn't the most popular -- many people see it as a massive and unnecessary tax break for the rich. Not only that, but the passage of a tax bill this year is far from certain at this point.

Having said that, if a tax bill does pass, there's a reasonable chance that the estate tax could be eliminated, which would make the estate tax exemption and annual gift exclusion meaningless.

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