Estate and Gift Tax Basics

Estate and Gift Tax Basics

Estates, gifts and generation skipping transfers have their own tax structure separate and independent from income taxes.  “Excess” amounts transferred or passing to others are subject to tax.  Here are some basics on how it works.

• Unlimited gifts or bequests to a spouse are tax free.
• Outright gifts up to $14,000 per year per person are tax free.  Note that certain gifts to a trust might not be eligible for the $14,000 exclusion.  (not covered here)
• Gifts over the $14,000 per person limit are aggregated over the donor’s lifetime and are not taxed until they exceed $5,250,000.
• The $14,000 and $5,250,000 dollar limits are doubled if the spouse consents.
• The $14,000 and $5,250,000 amounts will be adjusted periodically because of inflation.
• Gift tax returns are required to be filed to report taxable gifts and generation skipping transfers and also where there is a consenting spouse.
• If a cash gift of $28,000 will be made by one spouse, there will be no gift tax if gift tax returns are filed for the husband and wife claiming the consent.  If each spouse makes a gift of $14,000 to the same person, then no gift tax returns need to be filed to claim the exemption. Therefore, husbands and wives making cash gifts of up to $28,000 to the same person should each make separate gifts for half the amount to avoid filing gift tax returns.  This may not apply to non-cash gifts or cash gifts to a trust.  Check with your advisor.
• Direct payments of tuition and medical care do not count as a gift so are tax free.  Note: A gift of the exact tuition amount to the student who signs it over to the school does not qualify as a direct payment. The payment must be directly made to the school or medical care provider.
• Support of and other payments for your minor child do not count as a gift.
• Charitable contributions are not part of this tax.
• Gifts or bequests to someone more than a generation younger are subject to a generation skipping tax (GST) in addition to gift or estate tax.  An example is a gift from a grandparent to a grandchild.
• There is a single tax rate schedule with a 40% rate for all three taxes (Gift, GST and Estate), but the tax is applied differently, so it might be more beneficial to pay the 40% gift tax rather than wait and pay the 40% estate tax.  This requires planning with your tax advisor.
• Gifts and transfers can be made directly to someone or placed in a trust for his/her benefit.
• Gift tax returns accumulate excess gifts and generation skipping transfers by including all prior years’ gifts.
• If “taxable” gifts are made that are not taxed because the lifetime exemption offsets it, then the lifetime exemption will be that much lower when the person dies and the estate tax return is filed.
• Gift tax returns become a permanent record that can be audited when filed, or when the donor dies (sometimes decades later) depending upon the transactions and how they are reported on the gift tax return.
• All gift tax returns must be retained as they will be needed to be attached to the estate tax return when the donor dies.
• IRA, 401k, pensions and similar accounts are subject to both estate tax and income tax.  Estate tax when the participant dies, and income tax when distributions are made to beneficiaries.
• Capital gains existing at death are forgiven and won’t be subject to income tax, but will be subject to estate tax.
• Inherited capital gain property will have the basis stepped up to the value at the date of death, or a date six months later if a special election is made by the executor.
• Someone receiving a gift of appreciated property will assume the basis of the donor and when they sell those assets will have to pay tax on the capital gains existing when the gift was made, as well as any additional appreciation.
• Anything the decedent owned when they died will be subject to estate tax, subject to limits mentioned above.
• Life insurance the decedent owned on themselves will be included with their other assets to calculate whether estate tax will be due.
• Many states, including New Jersey and New York, have estate taxes with much lower exemptions.  These rules have not been covered here.  Check with your advisor for this information.

This is a brief listing of gift, generation skipping and estate tax rules.  It might seem confusing, and it is, but it is a real tax for those with assets over $5.25 million, and like any tax, a keen understanding, knowledge and sound planning can reduce some of the burden.