Estate and Gift Taxation

Federal Estate Tax Laws

As mentioned above, an estate tax is a tax on the assets of a person after they pass away and before the assets are distributed to the person's heirs. The estate tax is collected in 2021, only if the gross value of the estate is greater than the federal personal estate tax exemption of $11.4 million for an individual. The exemption is $22.8 million for a married couple.

So, only the value of the estate that is greater than $11.4 million in the case of a single individual, or $22.8 in the case of a married couple, would be taxed. That rate of the estate tax starts at 18% for amounts between $0 and $10,000 and tops out at a rate of 40% on amounts of $1,000,000 and above. If the value of an estate is less than $11.4 million, then the federal estate tax does not apply.

In addition to the personal estate tax exemption, there is also a marital deduction, which allows the estate of a person who has died, known as a “decedent” in legal terminology, to pass free of all taxation to their surviving spouse. This can happen as long as the property is directly transferred to the surviving spouse upon the decedent's death.

The gross value of an estate is calculated by totaling the fair market value of all property and assets owned by the decedent at the time of their death. This may include:

• Cash;
• Money held in bank accounts;
• Stocks;
• Bonds;
• Real estate if it is not held in joint tenancy or tenancy in common;
• Annuities may or may not be included;
• Intellectual property, such as copyrights, patents and trademarks;
• Personal property such as works of art, furniture, jewelry and the like.

Estate planning is the process of distributing a person's assets into certain kinds of trusts and other assets, such as life insurance, that would not be included in their taxable estate and thus would not be taxed. Deploying strategies such as these can reduce a person's exposure to the estate tax.

Historically, the number of estates subject to the estate tax was higher, as the exemption amount was $675,000 in the year 2000. The exemption increases every year. Over 50,000 estates were taxable in 2000. Today, the vast majority of estates, whether those of individuals or of married couples, are not subject to the federal estate tax. This means that most people are able to transfer their estates free from federal taxation. However, according to the federal government, 1,890 estates were still taxable in the U.S. in 2018.

An estate tax return must be filed and taxes paid upon the death of the decedent by the personal representative or executor of the estate within the 9 months from the date of the death. Of course, there are always exceptions and the period for paying the federal estate tax may be extended in certain circumstances.

Additionally, it is important to note that around 12 states and the District of Columbia have their own estate tax regimes. Thus, it is important to research not only federal gift and estate tax laws, but also the gift and estate tax laws of the state in which a person lives.

Twelve states and the District of Columbia collect estate taxes. Six states collect inheritance taxes, which is a tax paid by the person who receives a bequest from an estate. Inheritance taxes are based on the amount of the bequest paid to any individual heir. Only one state, the state of Maryland, collects both estate and inheritance taxes.

Hawaii and Washington State have the highest top tax rates for their estate tax at 20%. Eight states and the District of Columbia have a top rate of 16%. Massachusetts and Oregon have the lowest exemption levels for their estate tax, with an exemption of only $1 million. So, in Massachusetts and Oregon, the value of an estate that exceeds $1 million is subject to state estate tax. The state with the highest exemption, $7.1 million, is Connecticut. Connecticut is the only state that collects gift taxes, but the Connecticut gift tax is basically the same as the federal gift tax.

Of the six states that impose inheritance taxes, Nebraska has the highest top inheritance tax rate of 18%. Maryland has the lowest top inheritance tax rate at 10%. All six states exempt spouses from their inheritance taxes and some states offer either full or partial exemptions to immediate relatives.

State Estate or Inheritance Taxes

There are state estate or inheritance taxes. In addition to federal estate taxes, some states within the United States also collect estate taxes and/or inheritance taxes.

States which collect inheritance taxes as of 2020 include:

• Iowa;
• Kentucky;
• Maryland;
• Nebraska;
• New Jersey; and
• Pennsylvania.

It is important to note that each of these states have their own unique laws which define who is exempt from the state inheritance tax. This means that some estates or individuals in the states listed above may not have to pay an inheritance tax.

There are 11 states which have only an estate tax. These include:

• Connecticut;
• Hawaii;
• Illinois;
• Maine;
• Massachusetts;
• Minnesota;
• New York;
• Oregon;
• Rhode Island;
• Vermont;
• Washington State; and
• Washington D.C. 

What are the Federal Estate Tax Laws, and Have Estate Taxes Been Repealed by Congress?

As previously noted, the intent of federal estate taxes is to tax an individual's right to transfer their property at their death. As of 2021, federal estate taxes can be imposed on an estate by the federal government and these taxes may reach up to 40% of the total value of an estate.

It is worth noting again that many estates will not be subject to the taxes because the gross value of their estate will not exceed their lifetime exclusion. As of 2021, the lifetime exclusion for estate taxes is $11.7 million for individuals and $23.4 million for married couples.

There is an additional federal estate tax law which allows for a marital deduction. This law permits a decedent's estate to pass to their living spouse tax free.

Pursuant to this law, the estate of the first spouse will pass tax free to their surviving spouse under the marital deduction. However, this means that the value of the estate which remains when the second spouse passes away will be subject to federal or state estate taxation. 

Federal Gift Tax Laws

Federal gift taxes are taxes on the transfer of property from one person to another, where the donor receives nothing. In other words, the transfer is a gift and not the sale of an asset. The federal gift tax applies to these gift transfers, even if the donor may not have intended to make a gift. So, in the view of the Internal Revenue Service (IRS) it does not matter whether a donor actually intends for the transfer of property or an asset to be a gift. The donor, and not the recipient, is responsible for paying the tax.

Some of the more common gifts that are exempt from the federal gift tax include the following:

• Gifts made of assets that have a value of less than the annual exclusion amount for one year, i.e., less than $15,000 ($30,00 for married couples who file a joint return) to any one individual;
• Gifts to a spouse;
• Gifts that the donor makes for the purpose of paying the tuition or medical expenses of another person, known as educational and medical gift tax exclusions;
• Gifts made to certain political organization for their use; and
• Gifts made to charitable organizations that qualify under the Internal Revenue Code.

Importantly, with the annual exclusion amount, a person is allowed to make more than one $15,000 gift. This is because the annual exclusion provision allows a person to make multiple gifts to as many people as they want. For example, if a person has 8 nieces and nephews, the person may give each of them $15,000, for a total of $120,000, without having to pay federal gift tax. The important fact for tax purposes is that each gift is $15,000 or less.

However, if the person goes over the allowed annual exclusion amount with a gift to one person, they will likely still not have to pay a federal gift tax. This happens because the amount that exceeded the $15,000 could be added to the $11.4 million lifetime estate and gift tax exemption amount. 

What Else Should I Know About Personal Gifts In a Will?

A gift distributed through a will after death is known as a “testamentary gift.” A gift distributed while the person is still alive is referred to as an “inter vivos gift.” Generally speaking, inter vivos gifts are transferred through means other than a will, such as a living trust.

Whether to distribute gifts during life or after death is mostly a matter of individual preference. If the property owner will still be using the property up until their death, it may be better to transfer the gift through a will. However, if they would like to have property distributed to a recipient while they are still alive, it may be better to transfer it as an inter vivos gift.

Testamentary gifts are sometimes revocable. Meaning, they can sometimes be revoked or withdrawn at the request of the donor. Because the gift will only be transferred upon the testator's death, they are free to use the property during their lifetime. Finally, the donor can generally place conditions on the gift. An example of this would be if the testator says the recipient is only to receive the gift once they have reached their 18th birthday.

Inter vivos gifts provide immediate gratification. Both the recipient and the donor will see the gift being used while the donor is still alive. Inter vivos gifts are permanent and irrevocable; meaning, the donor cannot repossess the item once it has been transferred. Finally, some inter vivos gifts are associated with various benefits such as considerable tax breaks.