There are two key numbers in the estate planning world: the "annual exclusion amount" and the "lifetime exclusion amount." As a result of 2013 legislation, the lifetime exclusion amount is now indexed for inflation, providing excellent planning opportunities. This article briefly describes these two key estate planning numbers and provides a few planning options.

The Annual Exclusion Amount

People often overlook one of the most effective methods of transferring wealth: the annual gift exclusion. Each year an individual can gift the annual exclusion amount to as many people as he/she chooses without paying gift tax, without reducing his/her lifetime exclusion amount (see below) and in some cases without filing a gift tax return. The annual exclusion amount is also indexed for inflation. In 2014, the annual exclusion amount is $14,000.

The following example shows the benefit of using the annual exclusion amount: Assume grandfather and grandmother wish to make gifts to their 3 children and 5 grandchildren. Grandfather can gift up to $112,000 without paying gift tax and without reducing his lifetime exclusion amount (8 recipients x $14,000 = $112,000). Grandmother can also gift up to $112,000 without paying gift tax and without reducing her lifetime exclusion amount. After 5 years, grandfather and grandmother are able to transfer more than $1 million to their heirs tax-free, potentially saving $400,000 in estate tax. The amount would be even higher if the grandparents gifted to their children's spouses.

As you can see from the example, the annual exclusion is a very powerful wealth transfer tool, but there are also a few hidden traps:

• Present Interests - The annual exclusion does not apply to all gifts. It only applies to gifts of present interests. Generally, a gift is a present interest if the recipient has possession and control over the property immediately after the gift.
• Gifts to a Trust - The terms of the trust will determine whether the annual exclusion amount can be applied to gifts made to trusts.
• Gift-Splitting - If an asset is held solely by one spouse, a married couple can choose to split the gift (i.e., one-half of the gift is treated as made by the donor spouse and the other one-half is made by the other spouse). Additional rules apply when gift-splitting is used and a gift tax return is generally required.
• Gifts to a Trust for a Minor - There are special rules that apply to gifts made to a trust for the benefit of a minor.
• Generation Skipping Transfers - If you intend to make gifts to grandchildren or to trusts that could benefit grandchildren, additional rules and details must be considered.

The Lifetime Exclusion Amount

The lifetime exclusion amount is the total value an individual can transfer during his/her lifetime or at death without paying federal estate/gift tax. This amount has changed significantly over time. In 2004, the exclusion was only $1.5 million. In 2014, the lifetime exclusion amount is $5.34 million. As a result of the 2013 tax law changes, this lifetime exclusion amount will increase every year based on an inflation adjustment. If you gifted $5.12 million in 2012 (the 2012 lifetime exclusion amount), you can make additional gifts up to $220,000 in 2014, without paying federal gift tax. The annual inflation adjustment provides a yearly opportunity for you to evaluate your estate plan and make course corrections if necessary.

If you have questions regarding gift and estate tax compliance and planning, please contact your Eide Bailly tax advisor or attend our wealth management and estate planning webinars  June 17-19.