Legal Definitions - exemption equivalent

The exemption equivalent refers to the maximum total value of assets an individual can transfer during their lifetime (through gifts) and at their death (through their estate) without incurring federal gift or estate taxes. It represents a cumulative, tax-free threshold for wealth transfer, meaning that transfers up to this amount are exempt from these specific federal taxes.

• Example 1: Estate Planning for Heirs

  Imagine a wealthy individual named Mr. Henderson, who has accumulated significant assets over his lifetime. He wishes to leave a substantial inheritance to his children and grandchildren. When Mr. Henderson passes away, his estate will be subject to federal estate tax only if the total value of his assets exceeds the prevailing exemption equivalent at the time of his death. If his estate is valued at, for instance, $15 million, and the exemption equivalent is $13.61 million, then only the amount exceeding $13.61 million (i.e., $1.39 million) would potentially be subject to federal estate tax. The first $13.61 million of his estate is protected by the exemption equivalent.

• Example 2: Large Lifetime Gift

  Consider Ms. Chen, who decides to help her daughter purchase a new home by gifting her $1 million. While there's an annual gift tax exclusion (allowing a certain amount to be gifted tax-free each year without using up any of the lifetime exemption), a gift of $1 million far exceeds this annual limit. The portion of the $1 million gift that is above the annual exclusion amount will reduce Ms. Chen's available exemption equivalent for future gifts or her estate. For instance, if the annual exclusion is $18,000, then $982,000 ($1,000,000 - $18,000) of her lifetime exemption equivalent would be used up by this gift, reducing the amount she can transfer tax-free later.

• Example 3: Spousal Estate Planning with Portability

  Mr. and Mrs. Rodriguez are a married couple with a combined estate of $20 million. When Mr. Rodriguez passes away, he only uses $5 million of his individual exemption equivalent for assets he leaves to beneficiaries other than his wife (transfers to a spouse are generally tax-free). Because of a provision called "portability," Mrs. Rodriguez can elect to add Mr. Rodriguez's unused exemption equivalent (in this case, $13.61 million - $5 million = $8.61 million, assuming the same exemption amount as above) to her own. This means that when Mrs. Rodriguez eventually passes away, her estate will have a much larger combined exemption equivalent, potentially allowing her to pass on more wealth tax-free to their children and grandchildren.