Gift Tax and Estate Tax: An Overview
Gift taxes and estate taxes could be imposed on the transfer of property from one person to another. But both can be minimized or avoided altogether with thoughtful estate planning. This article provides an overview of both forms of transfer.
Taxes are one of life's certainties. But that doesn't mean you shouldn't look for ways within the Internal Revenue Code to reduce your tax liability. Effective tax planning is essential to any financial plan for individuals, families, or businesses.
With respect to individuals, there are three types of transfer taxes:
- Gift taxes
- Estate taxes
- Generation-skipping transfer taxes
This FindLaw article provides an overview of two transfer taxes: the gift tax and the estate tax. These could be imposed on the transfer of property from one person to another. Thoughtful estate planning can minimize or eliminate these taxes.
Personal Gifting and the Federal Gift Tax
People choose to gift for a variety of reasons, such as:
- A family member or loved one is in need, and the donor wants to help.
- The donor wants to make a difference in someone's life or the world.
- It would be financially beneficial for the donor to reduce the size of their estate, for tax purposes, during their lifetime (to avoid various taxes now and estate taxes later).
Gifting to an individual beneficiary is not the same as making a charitable donation to a tax-exempt nonprofit or private foundation. You cannot deduct a personal gift from the adjusted gross income on your tax return. In general, gifting will not reduce your tax liability in the year you make the gift. It could increase your taxes if your gift triggers a federal gift tax (or, as in Connecticut, a state gift tax).
If you are considering personal gifting, it's important to understand the IRS gift tax exemption and exclusion rules. A federal gift tax can apply to gifts of money or things with monetary value, such as:
Personal gifting occurs when you give an item of monetary value and don't receive something of equal or greater value in return.
Gifting more than is allowed by law or for unapproved purposes can trigger a gift tax at some point. The tax is paid by the donor, except in special arrangements. The recipient does not pay income tax on the gift received.
Gift Tax Exemptions
There are three main exemptions for gift taxes:
- Gifts to spouses: Gifts between spouses are 100% exempt from gift tax if the spouse is a U.S. citizen.
- Gifts to charity: A gift to a qualified tax-exempt charity is not considered a taxable gift. It is a charitable contribution. It is not only exempt from the gift tax but also deductible up to 100% on the donor's adjusted gross income on their tax return.
- Gifts to political organizations: To learn more about how the gift tax exemption applies to political contributions, see the Internal Revenue Service Code 527.
Gift Tax Exclusions: Gifts to Individuals
Each year, a donor can gift any individual money or property up to a particular dollar value set by the IRS. As of 2023, the annual exclusion amount was $17,000 per recipient.
If a married couple gives a gift to an individual, they can together give $34,000. The gift exclusion amount changes, so check with your tax advisor, tax attorney, or the IRS for up-to-date tax law information.
Who Can Receive Individual Gifts?
You can give gifts to anyone you choose. It could be a family member, a friend, or someone in need. And you can give to as many people as you like. Each person can receive a gift up to the annual gift tax exclusion amount.
Or course, you can choose to give more than that amount. As the donor, however, you may have to pay a gift tax on the amount of your annual gift above the annual gift tax exclusion limit. (More on this later.) The tax rate for that portion of your gift would range from 18% to 40%. See IRS Gift Tax Return Form 709 to learn more.
A donor can pay school tuition or medical expenses on someone's behalf without triggering a gift tax. The donor must make payments directly to the school (any grade level or college) or to the medical provider, pharmacy, or medical insurer. Again, you can gift to anyone you choose, with no dollar limit on these payments.
Lifetime Gifting Limits
Every American taxpayer has a lifetime gift exclusion amount. This tax credit unifies the gift and estate taxes into one tax that decreases the tax bill of the individual or estate. The lifetime exemption amount is much larger than the annual gift tax exclusion.
For many years, the limit increased incrementally, but with the 2018 tax reform law, the lifetime gift exclusion amount nearly doubled. In 2023, the exemption amounted to $12.92 million per donor. Unless Congress changes the law, the exemption will drop to $6.2 million at the end of 2025.
You can give up to the annual exemption amount each year without affecting your lifetime gifting limit. If you exceed the annual amount in any year, that will be deducted from your lifetime exemption and your federal estate tax exemption.
Examples of Individual Gifting
Elizabeth becomes seriously ill and cannot work for a time. Her parents can provide $32,000 toward her daily living expenses without concern about a gift tax. They can also pay her health insurance premiums and medical deductibles with no dollar limit. The donee, their daughter, has no tax liability for this money.
College is important to Jason's grandfather. He started putting money into a 529 account soon after Jason was born. Now, he wants to ensure Jason can fully devote himself to his studies. Jason's grandfather does not want Jason to work while he is in school. Jason's grandfather can give Jason an outright gift of $17,000, which Jason can use to pay for his dormitory housing and food. Funds from the qualified 529 education account can pay for tuition and books. Grandpa can also pay any uncovered education expenses directly to the college.
Gift Tax Surprises
Knowing how transfer taxes work can save you from unwanted gift tax surprises. Generous family and friends could find themselves with a surprise bill from the IRS for a gift tax they did not expect. Some examples of this could be:
- A friend buys a new car and gives you their used car, which has a fair market value of $20,000. That's $3,000 over the gift tax exclusion limit, and the difference could be a tax liability to the donor.
- Grandma picks up the tab for a grandchild's wedding. Depending on the total cost of the event, those funds constitute a potentially taxable gift.
- You loan your brother $25,000 to pay off his credit card debt, but he never pays you back. Later on, you tell him he doesn't need to repay you. You're just glad he's back on his feet again. But now that loan has become a gift, $8,000 over the gift exclusion limit.
- You loan your friend $2,000 for their first month's rent, with 0% interest. The IRS considers a loan without interest a gift, but it's below the exclusion amount. You won't see a tax bill.
- Your sister moves into your mother's house to care for her now that she can't manage on her own. It may make sense to put your sister's name on your mom's bank account because she'll need to pay the bills, but if your sister can use your mom's money at any time, the IRS will see it as a gift.
Several states and the federal government require the estate of a deceased person to pay estate taxes (some call them "death taxes"). The state where the decedent lived may impose a state estate tax. If the person owned real estate or personal property in another state, that state may also impose an estate tax.
Estates must file a federal estate tax return if the valuation of the "gross estate," minus exemptions and deductions, exceeds a specific dollar amount ($12.92 million in 2023).
How does the IRS determine the value of the gross estate? It adds the value (or share of value) of all property in which the decedent had an interest at the time of death and subtracts estate exemptions and deductions. This is the taxable estate value.
Estate Tax Exemptions
- Personal exemption: At any time, Congress may increase or decrease this amount or even repeal the estate tax altogether. As of 2023, the personal exemption amount was $12.92 million.
- Marital deduction: A person's estate can pass tax-free to a surviving spouse if the surviving spouse is a U.S. citizen and if the deceased spouse's interest in the estate passes directly to the survivor upon death.
Other deductions against the gross estate include:
- Probate expenses
- Funeral expenses
- Debts owed by the estate
- Taxes owed by the estate
- Charitable bequests
Life insurance policies usually avoid triggering the estate tax. Insurance proceeds are not included in the gross estate unless payable to your own estate.
In most cases, an insured person designates a beneficiary other than the estate to receive proceeds from a life insurance policy. Thus, the proceeds do not become part of their gross estate.
However, when the insured names the estate as the beneficiary, the proceeds become part of their gross estate. If the estate's value exceeds the federal exemption, the portion over the limit is taxable. Most people name individuals as beneficiaries, so the death benefit rarely becomes part of the estate.
Filing the Estate Tax Return
The executor, personal representative, or person in possession of the estate's assets must file the estate tax return no more than nine months after the decedent's death. The estate can apply for a six-month extension to file, but the taxes are due within nine months. Certain circumstances can extend the time for payment of the estate tax.
How Lifetime Gifting Affects Estate Taxes
Lifetime gifting can reduce the size of the taxable estate so that it never exceeds the amount that would trigger federal (or state) estate taxes. Of course, other strategies can minimize estate taxes, but annual gifting is a popular choice.
Here's an example of how lifetime gifting, the marital deduction, and the personal estate tax exemption might work together.
During Bob's lifetime, he gifted the maximum annual amount of money to his only child, Kate. He also paid for a college education for his daughter, niece, and nephews. His gifts to these and other family members increased to $1 million throughout his life.
Bob's estate is worth $22 million. His will states that $10 million go to his wife and $12 million to his daughter. No part of the $10 million Bob leaves to his wife will be subject to estate tax. Bob's wife is a U.S. citizen and has a spousal exemption. Kate's inheritance will also be free of the estate tax because it is less than the $12.92 million exemption. Because Bob had previously given away $1 million, his estate didn't go over the limit.
Questions About Gift Taxes and Estate Taxes? Talk to an Attorney
An experienced tax attorney or estate planning attorney can answer your questions about strategies you can use to reduce your liability for taxes due after death.
Can I Solve This on My Own or Do I Need an Attorney?
- DIY is possible in some simple cases
- Complex estate planning situations usually require a lawyer
- A lawyer can reduce the chances of a family dispute
- You can always have an attorney review your forms
Get tailored advice and ask your legal questions. Many attorneys offer free consultations.