Estate and Gift Tax
Estate and Gift Tax
Sections within this essay:Background
Gift Tax Return
Economic Growth and Tax Relief Reconciliation Act of 2001
Generation-skipping Transfer Tax
Farmers and Small Business Owners
American College of Trust and Estate Counsel
National Academy of Elder Law Attorneys, Inc.
Estate and gift taxes are a statutory method of taxation that are imposed on large transfers of money and/or property during an individual's lifetime or at death. Gift taxes are imposed on transfers made during an individual's lifetime. Estate taxes are imposed on transfers made as a result of death. Most gifts are not subject to the gift tax and most estates are not subject to the estate tax. According to the Internal Revenue Service, only about 2 percent of all estates are subject to estate taxes. Estate and gift taxes are methods the government uses to limit dynastic or familial wealth. Estate taxes are sometimes called death taxes.
An alternative form of death tax is an inheritance tax, which is a tax levied on individuals receiving property from the estate. Federal law does not provide for an inheritance tax, although some states have enacted such laws. A number of individual states also have enacted estate tax laws.
Although the taxation of gifts and estates may seem complex, the calculation of estate and gift taxes is similar to the calculation of personal income taxes. As with the income tax, there are exemptions and credits that are applied before the progressive rate schedule is applied. Estate taxes are different in that they are calculated over a lifetime, rather than year by year.
According to the Internal Revenue Code, a person gives a gift when he gives property (including money), to another without the expectation of receiving something of approximately equal value in return. A gift may also be the use of or income from property. Selling something at less than its full value, or making an interest-free or reduced interest loan, may also constitute a gift.
Although any gift has the potential to be taxable, there are a number of exceptions. For 2005, the first $11,000 given to any one person during the calendar year is not subject to the gift tax. That amount increases to $12,000 in 2006. Educational and medical expenses paid directly to a medical or educational institution for a person will not trigger gift tax provisions. Moreover, gifts to a spouse, a political organization, or charities are generally also exempt.
A separate $11,000 annual exclusion ($12,000 beginning in 2006) applies to each person to whom a gift is made. A person may give up to $11,000 each to any number of people each year and none of the gifts will be taxable. Married people can separately give up to $11,000 to the same person each year without making a taxable gift.
If a married couple makes a gift to a third party, the gift can be considered as made one-half by each person. This is known as gift splitting. Both spouses must agree to split the gift. Gift splitting allows a married couple to give up to $22,000 to a person annually ($24,000 in 2006) without making a taxable gift. If a gift is split, the couple should file a gift tax return proving the agreement to split the gift existed. This is true even where half of the split gift is less than $11,000 or $12,000 (depending upon the year given).
A gift tax return is filed with annual income taxes on Form 709. This form is required for gifts of over $11,000 to someone other than a spouse, or where a married couple is splitting a gift. If the gift is something the recipient cannot actually possess, enjoy, or receive income from until sometime in the future, Form 709 must be filed. It must also be filed where a person gives his or her spouse an interest in property that will be ended by some future event.
A gift tax return is not required for gifts to political organizations and gifts made for payment of tuition or medical expenses. A gift tax return is not required for certain charitable gifts, including those made to a qualified conservation easement. Under certain circumstances, a charitable gift also need not be reported if the gift is for an entire interest in property.
Most gifts above the annual exemption are still not subject to tax because each taxpayer is allowed a lifetime credit against taxable gifts and estate. This credit reduces or eliminates the amount of taxes owed. A unified credit applies to both the gift tax and the estate tax. The unified credit is subtracted from any gift tax owed by the taxpayer. Unified credit used against a gift tax in one year reduces the amount of credit that can be applied against a gift tax in later years. The total amount used against a gift tax reduces the credit available to use against estate tax. In other words, any unified credit not used against gift tax during the taxpayer's lifetime is available to reduce or eliminate an estate tax.
Previously, the law provided the same unified credit amount for both the estate tax and the gift tax. Under current law, however, the unified credit against taxable gifts is $345,800. This credit has the effect of exempting $1 million from tax. This amount will remain the same through 2009. The unified credit amount for estate tax purposes, on the other hand, changes from year to year.
The unified credit for estate tax purposes is $555,800, for a person who dies in either 2004 or 2005. This excludes $1,500,000 from estate tax. In 2006, 2007, and 2008, the unified credit for estate tax purposes is $780,800. This figure translates to an exclusion amount of $2 million from tax. In 2009, the unified credit rises to $1,455,800; the exclusion amount is $3,500,000.
A person's taxable estate is defined as the gross estate less allowable deductions. Gross estate means the value of all property in which the decedent had an interest at the time of death. The gross estate includes life insurance proceeds payable to the estate or the heirs, the value of certain annuities payable to the estate or heirs, and the value of certain property transferred three years or less prior to death. Estate taxes are due to the IRS nine months from the date of death. The estate tax return is Form 706.
The taxable estate includes the value of all property and assets owned at the time of death plus any gifts made in the three years prior to death. Allowable deductions from a decedent's taxable estate include funeral expenses, debts the decedent owed at the time of death, costs of administering and settling the estate, and the marital deduction. The marital deduction encompasses the value of property that passes from an estate to a surviving spouse.
Any unified credit not used to eliminate gift tax can be used to eliminate or reduce estate tax. The maximum tax rate for the estate of a person who died in 2005 is 47 percent. The rate falls to 46 percent for the estate of someone who dies in 2006, and to 45 percent for someone who dies in 2007, 2008, or 2009.
The recipient of a gift or an estate is not liable for the gift or estate tax. An estate's executor is responsi-ble for payment of any estate tax that is due; the donor is responsible for payment of a gift tax, if one is due. Moreover, gifts and inheritances are not subject to income tax.
The federal estate tax law was enacted in 1916; 1997 amendments to the estate and gift tax laws raised the amount of unified credit over a nine-year period. In 2001 Congress further amended estate and gift tax laws.
The 2001 legislation increased the amount that is exempt from estate tax, while reducing the maximum tax rates on taxable property. Beginning in 2002 and through 2009, the top federal estate and gift tax rates drops from 55% to 50% in 2002, and then by one percentage point annually until reaching 45% for 2007, 2008, and 2009. Gift tax rates will be reduced on the same schedule as the estate tax rate. The law also substantially increased the amount that individuals can pass to their heirs free of federal estate taxes from $1 million in 2002 and gradually to $3.5 million in 2009.
The 2001 law provided that the federal estate tax will be completely eliminated in 2010. However, the law has a "sunset" provision which means that if Congress passes no additional law, the estate tax laws in effect prior to the Tax Relief Act of 2001 would be reinstated in 2011. This means that in 2011, the estate tax exemption will be $1 million and the top tax rate will be 55 percent, if the law is not amended before then.
The future of federal estate tax law is uncertain. President George W. Bush is in favor of a permanent repeal of the tax. In 2002 Congress narrowly rejected legislation that would have permanently repealed the estate tax.
Unlike the estate tax, the gift tax has no sunset provision in 2010, and taxpayers will still be subject to a lifetime gift tax. From 2002 through 2009, the top marginal estate tax and gift tax rates are the same. For 2010, gifts in excess of the $1 million exclusion amount are subject to a gift tax at a rate equal to the top individual income tax rate, 35 percent.
Generation-skipping transfer tax (GST) applies when a person omits their own children as beneficiaries and instead leaves the inheritance directly to their grandchildren. The GST tax rates and exemptions were also changed in the 2001 law. The GST exemptions match the estate tax exemptions, and the top tax rate falls accordingly, to a rate of 45 percent in 2009. Mirroring the estate tax, the GST tax also contains a sunset provision for 2010 only.
A driving force behind the 1997 and 2001 changes to estate and gift tax laws was to provide some relief to farmers of family-owned farms and other small business owners. Because these two groups often posses a significant amount of business assets, they are more likely than other taxpayers to be subject to estate taxes. Congress responded by enacting provisions for special-use valuation of farmland, a family-business deduction, and installment payment of estate taxes.
A special formula to reduce the value of real estate is employed where heirs continue to use the property as a family farm or business. Moreover, they may not sell it to a non-relative for at least 10 years. This special use valuation serves to reduce the market value of the real estate of most farms by anywhere from 40 to 70 percent.
For estates where farm and business assets amount to more than 35 percent of the gross estate, the estate tax may be paid in installments over a 14-year period. The law provides reduced interest rates, and only interest payments are required for the first five years.
Federal law previously included a credit for state death taxes, but the 2001 law changes phased out the state tax credit and replaced it with a deduction for state estate taxes paid. This change in the federal law spurred some states to reduce or eliminate their state death taxes.
Options for Reforming the Estate Tax. Burman, Leonard E., William G. Gale, and Jeffrey Rohaly, Tax Policy Center, April 18, 2005.
Publication 950. Internal Revenue Service.
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