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.
What Are 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.
What Are the 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.
Should I Hire an Attorney for Help with Federal Gift and Estate Tax Issues?
As can be seen, 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.
