Federal estate and gift taxes are really a single tax on the value of property transferred from one person to another. The gift tax applies to transfers during life and the estate tax to transfers on death. Estate and gift tax rates are high. Top rates have ranged between 35 percent and 55 percent in recent years. For 2019, the top tax rate is 40 percent. However, despite the high rates, very few gifts and estates are actually taxed because of generous exclusions and deductions.
THE ESTATE TAX
LIFETIME ESTATE AND GIFT TAX EXCLUSION
Each individual is entitled to transfer a certain dollar value of property without any estate (or gift) tax liability. For deaths in 2019, the individual exclusion is $5.45 million. It is indexed annually for inflation so it will probably increase each year. The amount of the exclusion is reduced by any taxable gifts you have made during your life. Because of the exclusion, only around .1 percent of estates will be subject to estate tax.
PROPERTY INCLUDED IN YOUR ESTATE
Your estate consists of everything you own at the date of your death. Included in your estate are real estate, cash, stocks, bonds, annuities, businesses, and life insurance policies that you own. All assets you own are included whether they must pass through probate or not.
The value of your estate is the fair market value of each asset on the date of death or on the alternate valuation date, six months after your death.
PROPERTY NOT INCLUDED IN YOUR ESTATE
Generally, your estate does not include property owned solely by your spouse or other individuals. Lifetime gifts over which you have retained no powers or other control are not included (but taxable gifts will reduce the amount of the lifetime exclusion available to your estate).
ESTATE TAX DEDUCTIONS
The value of your estate is reduced by the following deductions.
- Marital deduction. All property included in your estate that passes to your surviving spouse is eligible for the marital deduction. The property must pass “outright.” Some life estates also qualify for the marital deduction.
- Charitable deduction. If you leave property to a qualifying charity, it is deductible from your gross estate.
- Mortgages and debt.
- Administration expenses of the estate.
- Losses during estate administration.
PORTABILITY OF EXCLUSION FOR MARRIED COUPLES
If you are married, you and your spouse are entitled to a special benefit that allows you to use the marital deduction and your combined personal exclusions to reduce or eliminate estate taxes you might otherwise owe. If the first spouse to die does not use his or her entire exclusion, the surviving spouse can make an election to transfer such deceased spouse’s unused exclusion amount to the surviving spouse. This portability rule eliminates the risk of losing part or all of the lifetime exclusion of the first spouse to due, if it was not fully used at the death of the first spouse.
For example, suppose a husband dies leaving his entire estate of $5 million to his wife. He doesn’t need to use any of his exclusion to avoid estate taxes because property left to a spouse is not subject to estate tax. When the wife dies, her estate is valued at $8 million. If the wife made an election to transfer her husband’s unused exclusion, then her estate won’t owe any estate tax, because her estate can use her full exclusion, plus the husband’s unused exclusion. As mentioned previously, in order to utilize the deceased spouse’s unused exclusion, the estate of the deceased spouse must make the portability election on timely filed federal estate tax return.
THE GIFT TAX
THE ANNUAL GIFT TAX EXCLUSION
Most gifts are not subject to gift tax because of the annual exclusion. The annual exclusion allows you to give away gifts up to a certain value to an individual tax-free each year. The amount of the annual exclusion is $15,000 for gifts in 2019. Like the estate tax exclusion, it is also indexed for inflation and typically rises each year. You can give away gifts up to the annual exclusion to as many people as you like. For example, if you have three children, you can give each child $15,000 a year (a total of $45,000) without making a taxable gift. You and your spouse are each entitled to an exclusion, so together you can double the amount of the gift to each person without any tax liability.
The amount of any gifts you make above the annual gift tax exclusion counts against your lifetime estate and gift tax exclusion. Even if you don’t owe any tax on such gifts, you still need to file a gift tax return.
OTHER GIFTS NOT SUBJECT TO GIFT TAX
In addition to gifts worth less than the annual exclusion, the following gifts are not taxable gifts.
- Tuition or medical expenses you pay for someone, but you must pay them directly to the educational institution or health care provider.
- Gifts to your spouse.
- Gifts to a political organization for its use.
- Gifts to qualifying charities.