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Estate and Gift Taxation

Estate and Gift Taxes

Federal gift and estate taxes are taxes that are collected from individuals by the federal government when individuals make transfers of assets to people. When assets are transferred while the person making the transfer is still alive, then it is considered a gift. A gift tax may be collected by the Internal Revenue Service (IRS).

If the assets are transferred to another person when the transferor passes away, then the assets are an estate. An estate tax may be imposed on the estate before it is distributed to the heirs of the deceased person. Whether or not the gifts that a person makes or the estate that a person leaves behind are subject to federal taxation depends in part on the value of the gift or the estate. In addition, certain assets are excluded from taxation for various reasons. Both kinds of tax are discussed in more detail below.

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. 

What is the Tax Treatment of Gifts Made within Three Years of Death?

When an individual passes away, there may be estate taxes which apply to the transfer of their property at their death. An estate tax is a tax on the transfer of the estate from the individual who is deceased, or the decedent, to their beneficiaries, or individuals who are inheriting from the decedent.

This tax is imposed upon the estate itself, not upon the beneficiaries. The total tax which is owed is calculated by adding the fair market value of all of the decedent's assets, both real and personal property, as of the date of their death.

Before their death, an individual may seek to reduce the amount of estate tax by making gifts to other individuals. This will reduce the total value of their estate.

Therefore, if the estate tax applies at death, it will apply to an estate where the value has been reduced by the amount of gifts which were given to other individuals. A smaller estate is subject to a smaller amount of estate tax compared to a larger estate.

Tax laws do not permit an individual to gift their entire estate if the gifts are made sufficiently close to the individual's date of death. This prohibition on gifting is intended to prevent avoidance of paying estate taxes.

How Does Tax Law Treat Gifts Made Within Three Years of Death?

According to federal tax law, if an individual makes a gift of property within 3 years of the date of their death, the value of that gift is included in the value of their gross estate. The gross estate is the dollar value of their estate at the time of their death.

A gift which is made during the lifetime of the individual who makes it is called an inter-vivos gift, or a gift between living individuals. A gift, similar to an estate, is subject to tax.

The individual who makes the gift is required to pay the tax, now the individual who receives the gift. The amount of gift tax which a pays while they are still alive is also included in the value of the estate.

When an individual makes a gift, the first $15,000 value of that gift is not taxed. In other words, the first $15,000 of the gift is excluded from taxation.

This exclusion is referred to as a gift tax exclusion. The amount of this exclusion is set by law and can vary from year to year, so it is important to verify prior to giving any gifts.

If a gift exceeds $15,000 in value, then the value of that gift which exceeds the $15,000 is subject to a gift tax. The percentage of that gift tax may range from 18% to 40% of the value of the gift which exceeds $15,000. The amount of this gift tax which is paid will be included in the value of the decedent's estate, as noted above, if the gift which was tax was made within 3 years of the date of the death of the decedent.

The gift itself is only included in the total estate value to the extent that the gift is more than $15,000. In other words, if a gift is made within 3 years of the decedent's death and that gift is worth $25,000, only $10,000 of that gift, the amount above the sum which is excluded from tax, will be included in the gross estate.

The gross estate, as noted above, will also increase by the amount of the gift tax which was paid on the gift.

Are There Exceptions to the Rule for Gifts Made Within Three Years After Death?

An individual may set up a revocable trust, or a living revocable trust, to avoid having the value of a gift being included in their gross estate. This is a type of trust which is created by an individual, called a settlor, during the settlor's lifetime.

In most cases, the settlor may revoke or cancel the living revocable trust as they choose to. In general, if a settlor wishes to control the assets in the trust during the rest of their life, then they can do so.

If the settlor continues to control the trust assets until they pass away, then the assets of the trust are included in the value of the estate. If this occurs, the assets are subject to estate tax. The law regards trust assets which are within the actual control of the settlor at their death to be assets of the estate.

There is one exception to the three year rule requiring the amount of a gift made by an individual within 3 years of their deal to be included in an estate. This exception applies if the settlor of the revocable trust makes a gift of the assets in the trust to another individual during the settlor's life.

If this occurs, then the value of that gift is not included as part of the gross estate. This exception will apply even if the gift was made within 3 years of the death of the settlor.

How Can I Avoid Paying the Gift Tax?

An individual can avoid paying the gift tax by:

  • Donating a gift to charity;
  • Limiting any gifts to $15,000 or less as of 2021;
  • Giving a gift or leaving money to a spouse;
  • Paying another individual's medical or school expenses; and
  • Arranging for the individual receiving the gift, or the donee, to pay the gift tax.

It is important to note that gifts of any amount given between spouses are 100% deductible for gift tax purposes. This is called the unlimited gift tax marital deduction. This only applies to spouses who are United States citizens.

How Can An Attorney Help Me With My Federal Gift and Estate Tax Issues?

It is to your advantage to have the assistance of an estate attorney for any estate planning needs or questions you may have. Estate law is often complex due to the changing nature of both the federal and the state tax laws. In addition, proper estate planning is essential to ensure that your estate is distributed according to your wishes. Estate planning is also necessary to ensure that your estate does not owe any estate taxes upon your death. There are many estate planning tools which can be used to ensure that your estate is not subject to federal or state taxation. An estate attorney is best equipped to help you plan your estate and protect your assets upon your death.

Federal gift and estate tax laws are complicated. A person is well-advised to consult with an experienced gift tax lawyer regarding gift taxes and an experienced estate tax lawyer for advice about inheritance and estates. The best time to seek expert legal advice is before making gifts so that you can plan to avoid the gift tax, if possible. Likewise, a person with assets would want to consult an estate tax lawyer to plan their will or set up a living trust or use other strategies in order to avoid the estate tax.

Your attorney can provide advice regarding how to avoid estate taxes by establishing trusts or making gifts throughout your lifetime. Your attorney can also draft any estate planning documents on your behalf.