Estate and Gift Taxes at a Glance: Understanding the Basics
When an individual passes away, they leave behind assets such as real estate, investments, cash, and personal property. The taxes imposed on the value of these assets is referred to as estate tax. On the other hand, when an individual gifts an asset to someone, they may be subject to a gift tax. Both estate tax and gift tax are closely interrelated, and understanding their implications is vital for people who are planning to pass on their wealth to future generations.
In this article, we will provide you with an overview of estate and gift taxes and how they impact you as an individual.
What is Estate Tax?
Estate tax, also known as inheritance tax, is imposed on the transfer of assets when someone passes away. The value of the estate (assets owned by an individual) is calculated, and the taxes are imposed on the net value of the estate. The net value is determined by subtracting the debts and liabilities from the gross value of the estate.
In the United States, estate taxes are imposed at the federal level as well as the state level. The federal estate tax is administered by the Internal Revenue Service (IRS), whereas state taxes vary depending on the state you reside in. Currently, twelve states and the District of Columbia impose an estate tax.
What is the Federal Estate Tax Exemption?
The federal estate tax exemption is the amount of net value of an estate that is exempted from federal taxes. The exemption has steadily increased over the years, and in 2021, the estate tax exemption is set at $11.7 million per person. This means that individuals whose estate value is less than $11.7 million at the time of their death do not have to pay any federal estate taxes.
It is worth noting that the estate tax exemption is portable between spouses. This means that if one spouse doesn’t use their entire exemption, it can be passed on to the surviving spouse. For instance, if one spouse dies in 2021 with an estate value of $8 million, their unused exemption of $3.7 million can be transferred to the surviving spouse. This allows the surviving spouse to have a total estate tax exemption of $15.4 million, which is the combined exemption of both spouses.
How are Estate Taxes Calculated?
The estate tax rate is based on a progressive system that starts at 18% for estates worth up to $10,000 and goes up to 40% for estates worth more than $1 million. Additionally, the federal government allows for deductions that help reduce the taxable estate. These deductions include funeral and administrative expenses, debts, charitable donations, and family allowances.
What is Gift Tax?
Gift tax is a tax imposed on the transfer of gifts from one person to another. The Internal Revenue Code (IRC) defines gifts as any transfer of property, cash, or assets without receiving anything in return, or when an asset is sold for less than its fair market value.
Similar to estate taxes, gift taxes are imposed at both federal and state levels. However, the rules and regulations regarding gift taxes are different from estate taxes.
What is the Gift Tax Exemption?
The federal gift tax exemption is the amount of gifts that an individual can give to another person without having to pay any gift taxes. In 2021, the federal gift tax exemption is $15,000 per person per year. This means that an individual can give $15,000 in cash or assets to any person without having to pay any gift taxes.
It is worth noting that the gift tax exemption is not a lifetime exemption, unlike the estate tax exemption. The gift tax exemption is an annual exemption, which means it resets every year.
How are Gift Taxes Calculated?
If an individual gives gifts that exceed the annual gift tax exemption, they may be subject to gift tax. The gift tax rate is also based on a progressive system that starts at 18% for gifts up to $10,000 and goes up to 40% for gifts exceeding $1 million.
However, the federal government allows for certain exclusions and deductions that can help reduce the taxable gift. These exclusions include payments made directly to medical or educational institutions on behalf of the recipient.
What is the Relationship between Estate and Gift Taxes?
Estate taxes and gift taxes are closely related to each other. The federal government allows individuals to make gifts during their lifetime, which can help reduce the size of their estate and, therefore, reduce the amount of estate taxes they have to pay. One way to accomplish this is by making annual gifts up to the gift tax exemption limit to children or grandchildren.
Additionally, the federal government allows for a unified tax system between gift and estate taxes. This means that any gifts made during a person’s lifetime that are subject to gift tax will be deducted from their lifetime estate tax exemption. For example, if an individual gives $5 million in gifts during their lifetime, their estate tax exemption will be reduced by $5 million.
What are the Recent Changes in Estate and Gift Taxes?
In 2017, the Tax Cuts and Jobs Act (TCJA) was signed into law, which brought about significant changes to the estate and gift tax rules. The estate tax exemption was doubled from $5.49 million in 2017 to $11.18 million in 2018. Since then, the exemption has continued to increase, and in 2021, it stands at $11.7 million.
The TCJA also made changes to the federal income tax rate, which has impacted the amount of tax due on any income generated by an estate or trust. Estates and trusts now have a top marginal tax rate of 37%, whereas individuals have a top marginal tax rate of 37% for income of $523,601 or more.
Conclusion
In conclusion, estate and gift taxes are a complex subject that requires proper planning and execution to minimize the impact on an individual’s estate. It’s important to consult with a tax professional who can help you navigate the complicated tax rules and regulations.
Though estate and gift taxes can be expensive, they are designed to help equalize wealth distribution and fund public services. Understanding the basics and staying up-to-date with the changes in tax laws can help you make informed decisions about your estate planning and wealth transfer.
The estate tax and the gift tax, have been the subject of taxpayer dispute since both taxes were implemented. The estate tax is imposed after the death of the benefactor, while the gift tax is imposed on gifts made during their lifetime. In most cases, the gift tax is the responsibility of the benefactor, but not always. The estate tax is the burden of the estate, not the beneficiaries. The beneficiaries may be subjected to an inheritance tax, which is a separate from the estate tax.
In most states, children can receive a lifetime gift of a certain amount, tax free. On the federal level, children can receive a gift of up to one million dollars tax free, from their parents, in their lifetime. However, no more than fourteen thousand dollars can be gifted tax free, in any tax year. Â Each state may have differing gift limits for the tax year.
There are also some special considerations for the gift tax. For example, if an individual pays somebody’s medical bills, or tuition, the gift is tax exempt. There does not have to be a family relationship between the individuals, in order for those gifts to be tax exempt. In addition, gifts between spouse, are generally granted a gift tax exemption. Charitable gifts, including those to political campaigns, are also exempt from the gift tax in most cases.
The estate tax is imposed after the benefactor has passed away. The estate tax is paid from the value of the estate. The estate is generally taxed at its value, on the day the benefactor passes away.  The value of the estate is based on fair market value, rather than what any item  cost new. Many items will significantly increase in value, and others decrease, when utilizing the fair market value system.
Like the federal estate tax, most states allow for deductions from the value of the estate. Those deductions include funeral expenses, benefactor debt and estate administrative costs. Many states have allowed their estate taxes to lapse, in response to the federal government allowing their to lapse. In 2011, the Federal estate tax will be reintroduced, yet some states are choosing not to reinstate their estate tax.
The gift tax is implemented in many states. However, the rate of tax, and allowable deductions will vary in each tax jurisdiction. In addition estate taxes are imposed in several states, but the rates are effected by many intervening factors. Each tax jurisdiction will have varying allowable deductions and exemptions for the estate tax and the inheritance tax.
