Nothing is certain but death and taxes, the saying goes. Some taxes are avoidable, some are inapplicable, and some (like sales and use tax) just about everyone must pay.
One additional certainty – at least for the foreseeable future – is that less than 10 percent of Vermonters will be taxed for their generosity – during life or at death. If you think that’s all you need to know, check out the TLDR Caveat below.
Death Taxes
The United States has a long history of taxing the estates of the dearly departed, going back to Revolutionary War days. In the 1990’s, the term “death tax” became a politically popular way to describe taxation of transfers upon death. While I have no desire to opine on the morality or effectiveness of the death taxes, or whether the Founding Fathers would have approved, I will say it the term is useful shorthand for ill-understood concepts.
My friends Ron Morgan & Matt Getty noted in 2012, “It would be an understatement to say that estate planning to minimize potential federal and/or state estate tax liabilities has become considerably more complex in recent years.” At the time they wrote that, we had just been through a decade of declining federal estate and gift tax, followed by its reinstatement in 2011. Since the American Taxpayer Relief Act of 2012, however, things have settled down considerably, and the federal estate and gift tax exclusion (as it applies to “US persons”) has marched steadily upward.
Unified Gift and Estate Tax
The most frequently encountered (and debated) death tax at the federal level is what’s known as the Unified Gift and Estate Tax. The generally accepted view is that the tax is “unified” to close a gap in the estate tax. That is, if we only had an estate tax, everyone could simply give away their assets on the eve of death and avoid tax. (Another “loophole” is closed by the generation-skipping tax.) A more philosophical view might be taken from a truism and a pair of Bible quotes that have made their way down through the centuries into our common vocabulary:
- You can’t it with you;
- It is more blessed to give than to receive (Acts 20:35); and,
- From everyone who has been given much, much will be demanded; and from the one who has been entrusted with much, much more will be asked (Luke 12:48).
Regardless of its underpinnings, there is no reason to fear the gift tax for the vast majority of Americans, and for the “one-percent” (actually, a much smaller percentage) high exclusions are a “planning opportunity.” Unfortunately, many find gift taxation to be a mystery, and it’s definitely an area where a little knowledge is a dangerous thing. Let’s see why.
Federal Gift Tax Exclusion
First, although many call it an “exemption,” there are basically two federal gift tax exclusions: the annual and the lifetime. (I encourage you to check out the linked article from Nerdwallet – it goes quite in depth, whereas this blog post is just an overview. Before you do, though, check out my Caveat below.)
Annual Exclusion
In 2020, you can give gifts of up to $15,000 in value (the “annual exclusion amount”) to any individual, and to as many individuals as you wish, without filing a gift tax return, and without paying a tax (mindful of certain exceptions). You could make such gifts, up to the annual exclusion amount, every year of your life and never have to file a gift tax return or pay tax.
Lifetime Exclusion
On the other hand, perhaps you want to give your daughter a $30,000 car. The first $15,000 is excluded under the annual exclusion, but you can’t cut a car in half and give her half a car each year. So, the IRS requires that you file a gift tax return. Oh no! you think. Now I have to pay a tax!
Nope.
The lifetime exclusion in 2020 is $11,580,000 per individual (double that for married couples). In other words, if you had the means and the desire, you could have given away $11.58 million away to whomever you wanted (not counting gifts to tax-exempt organizations), and not pay a dime in federal tax if you died this year.
What about the Estate Tax?
Simple: since the gift and estate taxes are unified, so are the lifetime exclusion amounts, meaning that you can use your exclusion during life, at death, or in some combination thereof. It doesn’t matter when the transfer happens. Consequently, for most people I know – for most people anyone knows – the federal gift tax simply isn’t an issue.
So much for federal gift and estate taxes. What about Vermont?
Vermont Estate Tax
The Vermont estate tax exemption (for residents and others who own property in Vermont) is $4,250,000 in 2020 and will be $5,000,000 in 2021. Unlike the federal exemption, surviving spouses cannot use gift and estate tax credits from the deceased spouse, so these numbers apply to married and unmarried people alike.
While there is no actual gift tax, Vermont does have something of a “back-door” gift tax. The reason is that the “gross estate” for estate-tax purposes includes taxable gifts made within two years of death.
The procedure for arriving at the tax due is complicated and cumbersome (it involves pretending that a federal estate tax applies even if it doesn’t), but the upshot is that if you’re in the taxable neighborhood, it’s important to see both a CPA and an attorney about what you should be doing to preserve your legacy.
We can help.
Too Long Didn’t Read Caveat
If you made it this far or just skipped from the beginning, there are two things you absolutely must know:
- Never let the tax tail wag the estate planning dog. (I’d love to take credit for this phrase or its import, but I can’t.)
- Don’t think there aren’t consequences to gifts under the annual exclusion amount.
The latter point bears some elaboration. The vast majority of people do not have enough for retirement, let alone for long-term care. Of course, long-term care insurance may be one answer, but most of us don’t consider it until it’s too expensive. So, as I said in my post on Elder Law, Medicaid for Long Term Care will likely come into play. Now the important part. If you don’t take away anything else from this article, at least remember this:
Medicaid rules are not the same as gift-tax rules!
Medicaid’s five-year lookback means that any gift made during the five years before application can affect eligibility.
Go ahead. Write it down. Put it on your fridge.
Medicaid rules are not the same as gift-tax rules!
