Lifetime Gift and Estate Tax Exemption

The Lifetime Gift and Estate Tax Exemption (also known as the “unified credit”) is the total amount of assets a person can transfer to others, either during their lifetime as gifts or at their death as an inheritance, without having to pay federal gift tax or estate tax. Think of it as a giant, tax-free piggy bank given to you by the government. Every time you make a large gift (exceeding the annual limit), you dip into this piggy bank. Whatever is left in the piggy bank at the end of your life can be used to shield your estate from taxes. This “unified” system links gifting while you're alive with the assets you leave behind, making it a cornerstone of estate planning in the United States. While it's a US federal concept, its rules can surprisingly affect European investors who own US-based assets, making it a crucial topic for any serious international investor.

The beauty and complexity of this exemption lie in how it connects lifetime gifts with your final estate. The government tracks your major gifts over your lifetime, and that running total impacts how much of your estate is ultimately taxed.

Each year, you can give a certain amount to any individual without it affecting your lifetime exemption. This is called the annual gift tax exclusion. For any gifts above this annual amount to a single person, you must file a gift tax return (Form 709 in the US). You likely won't pay any tax at that moment; instead, the excess amount is subtracted from your lifetime exemption.

• Example: Let's say the annual exclusion is $18,000 and your lifetime exemption is $13 million. You give your child $118,000 to help with a down payment on a house.
  1. The first $18,000 is covered by the annual exclusion.
  2. The remaining $100,000 ($118,000 - $18,000) is a taxable gift.
  3. You file a gift tax return, and your lifetime exemption is reduced to $12.9 million ($13 million - $100,000). No tax is paid.

When you pass away, the value of your estate is calculated. Your remaining lifetime gift and estate tax exemption is then applied. If the value of your estate is less than your remaining exemption, no federal estate tax is owed.

• Continuing the example: You pass away with an estate worth $10 million. Since your remaining exemption is $12.9 million, which is more than the value of your estate, your heirs will pay zero federal estate tax.

Since 2011, the exemption has a feature called portability. This allows a surviving spouse to inherit any unused portion of their deceased spouse's exemption. This is known as the Deceased Spousal Unused Exclusion (DSUE). To secure it, the executor of the deceased spouse's estate must file an estate tax return (Form 706) to report the unused amount, even if no tax is due. This can effectively double the exemption for a married couple, providing a massive shield for preserving family wealth.

For a value investing practitioner, who focuses on the long-term compounding of wealth, understanding this exemption isn't just about taxes; it's about safeguarding the fruits of a lifetime of patient capital allocation.

Value investing is a marathon, not a sprint. The goal is to build substantial wealth over decades. A multi-million-dollar tax exemption is the primary tool for ensuring that the family's “compounding machine” can be passed to the next generation with minimal friction from the tax man. It protects the legacy you've carefully built.

A savvy value investor can use the exemption to make strategic lifetime gifts. By gifting an asset you believe is undervalued and has significant growth potential (like shares in a company you've researched thoroughly), you remove not only its current value from your estate but also all its future appreciation. This can be far more powerful than holding onto it until death. However, this must be weighed against the benefit of a cost basis step-up at death, where heirs inherit the asset at its market value on the date of death, erasing capital gains tax liability on past appreciation.

The lifetime exemption amount is a political football. The Tax Cuts and Jobs Act of 2017 (TCJA) dramatically increased the exemption, but this provision is scheduled to “sunset” at the end of 2025, potentially cutting the exemption amount by about half. A proactive value investor understands that planning based on current law is essential, as waiting could mean a much smaller exemption and a much larger tax bill later on.

The rules and stakes can be very different depending on your citizenship and where your assets are located.

This federal exemption is the main event in estate planning. However, be aware that several US states have their own, separate estate or inheritance tax. Critically, these state-level exemptions are often far lower than the federal one, sometimes starting at just $1 million. This means your estate could be tax-free at the federal level but still owe significant taxes to your state.

This is a critical warning. If you are not a US citizen but you own US-situs (located) assets, you may be subject to US estate tax. This includes assets like:

• US real estate (e.g., a vacation home in Florida).
• Stocks and bonds of US companies held in a non-US brokerage account.

The problem? The lifetime exemption for non-resident aliens is a minuscule $60,000, not the multi-million-dollar amount available to US citizens. Owning even a modest portfolio of US stocks could unknowingly expose your heirs to a significant and unexpected US tax liability. Proper planning, often through specific treaties or ownership structures, is essential for any international investor with US assets.