What Is the Current Estate Tax Limit, Rate, and Exemption?
The 2016 Estate Tax Limits, Rate, and Exemptions Have Been Announced by the IRS
Question: What is the current estate tax rate and limits?
Answer: The new estate tax limit for 2016 has been adjusted for inflation and officially announced by the IRS. Each individual person can leave behind $5,450,000 before having his or her estate subject to Federal estate taxes, which are levied at a rate of 40% for amounts over the exemption. Married couples can opt to combine their estate tax exemptions (the paperwork must be done correctly when the first spouse dies!), bringing it to $10,900,000; a huge advantage when passing on wealth to children, grandchildren, nieces, nephews, and other family members.
(Note: Estate taxes and gift taxes do not apply to transfers between most married couples in the United States. A married person can gift or bequeath, in life or upon death, unlimited assets to his or her husband or wife without paying any estate taxes or gift taxes; another of the many significant financial benefits of marriage.)
These figures are increased from $5,430,000 per individual, or $10,860,000 per married couple, over the estate tax exemptions in place during 2015. The estate tax rate itself was left unchanged with the bite taken by the IRS coming in at 40% of the excess amount over the exemptions.
The Estate Tax Is Tied to the Lifetime Gift Tax Exemption
Under the current law, the $5,450,000 individual, or $10,900,000 married, estate tax exemption is tied to identical lifetime gift tax exemptions ($5,450,000 per individual or $10,900,000 per married couple). Here is a quick and easy explanation of what that means in practical terms.
Each year, you can give a person $14,000 without having to pay gift taxes on the money (there are general exceptions to this rule; e.g., you can pay unlimited amounts for tuition and college expenses). If you are married, you and your spouse can combine your exemption, taking it to $28,000.
Imagine you had four children to whom you wanted to make a tax-free gift.
You could give each of the four $14,000 ($56,000 total) and your husband or wife could give each of the four $14,000 ($56,000 total). That means in a single calendar year, you were able to gift $112,000 without paying gift taxes.
What if you wanted to give each child $1,000,000? You could go ahead and do it, either opting to pay the gift tax on the $888,000 amount in excess of the annual gift tax exclusions, or, instead, using part of your lifetime gift tax exclusion allowance, which is tied to your estate tax exemption. You would claim it and the $888,000 would come off the $10,900,000 estate tax exemption you shared with your spouse. That means that if you both died, you'd only be able to pass on $10,012,000 to your heirs before paying the 40% estate tax.
This can be an intelligent strategy because it removes assets from the estate, at which point the assets can compound in the children, grandchildren, or other heirs' hands. An illustration might help.
An Example of Using the Estate Tax Limits Early By Claiming Your Lifetime Gift Tax Limit Exclusion
Imagine that a married couple, Thomas and Elizabeth, decide to gift $10,900,000 to their children outright above and beyond their annual gift tax exemption.
This will use 100% of their lifetime gift tax exemption and mean that estate taxes will be owed from the first penny left behind when they die. They expect to be live another 25 years based upon ordinary life expectancy projections. Two things have now occurred:
- The $10,900,000 can be invested by the children with all of the capital gains, dividends, interest, and rents growing in their respective estates. If the children could compound their money at 8% per annum for 25 years, they'd have $74,648,380. The $63,748,380 that has accrued during their ownership isn't counted as part of the parents' estate so it effectively side-stepped the estate tax.
- Whenever there is an inflation adjustment to the estate tax exemption, the differential gets added back to Thomas and Elizabeth's estate. For example, we talked about how the estate tax exemption increased to $10,900,000 in 2016 from $10,860,000 in 2015. That's an extra $40,000. If a person had used all of their estate tax / lifetime gift tax exemption of $10,860,000 last year, they'd wake up to find themselves with $40,000 in freshly granted exemptions of which they can take advantage at their convenience. Over a quarter-of-a-century, Thomas and Elizabeth are likely to be able to transfer even more assets as the exemptions are raised in nominal terms, plus they still have the $14,000 per person, per recipient annual gift tax exemption they can use at their discretion.
In practical terms, it's possible to get around the estate tax and gift tax exemptions even more effectively by utilizing things such as liquidity discounts in family limited partnerships and discounted family loans at the lowest applicable Treasury rate required by IRS regulations. With a 25-year time horizon, a good advisor earning satisfactory rates of returns on assets should be able to get $100,000,000 or more (in some cases, substantially more) into the hands of the heirs without paying estate taxes.