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Gift and estate taxes

If you give away money or property during your life, those transfers may be subject to federal gift tax and perhaps state gift tax. The money and property you own when you die (i.e., your estate) may also be subject to federal estate taxes and some form of state death tax. You should understand these taxes, especially since the passage of the Economic Growth and Tax Relief Reconciliation Act of 2001 (the 2001 Tax Act) and the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the 2010 Tax Act). The 2001 and 2010 Acts contain several changes that are complicated and uncertain, making estate planning all the more difficult.

Federal gift tax and federal estate tax--background

Under pre-2001 Tax Act law, no gift tax or estate taxes were imposed on the first $675,000 of combined transfers (those made during life and those made at death). The tax rate tables were unified into one--that is, the same rates applied to gifts made and property owned by persons who died in 2001. Like income tax rates, gift and estate tax rates were graduated. Under this unified system, the recipient of a lifetime gift received a carryover basis in the property received, while the recipient of a bequest, or gift made at death, got a step-up in basis (usually fair market value on the date of death of the person who made the bequest or gift).

The 2001 Tax Act and the 2010 Tax Acts substantially changed this tax regime.

Federal gift tax

The 2001 Tax Act increased the applicable exclusion amount for gift tax purposes to $1 million. The 2010 Act increased the applicable exclusion amount for gift tax purposes to $5 million in 2011 and 2012 (plus indexing in 2012). The top gift tax rate is 35 percent in 2010 to 2012 (the top marginal income tax rate in 2010 to 2012 under the 2001 Tax Act and the 2010 Tax Act). In 2013, the gift tax rates are scheduled to revert to pre-2001 Tax Act levels, with a top gift tax rate of 55 percent. In 2013, the applicable exclusion amount is scheduled to be $1 million. The carryover basis rules remain in effect.

However, many gifts can still be made tax free, including:

  • Gifts to your U.S. citizen spouse (you may give up to $136,000 (in 2011, $134,000 in 2010) tax free to your noncitizen spouse)
  • Gifts to qualified charities
  • Gifts totaling up to $13,000 (this figure is indexed for inflation so it may change in future years) to any one person or entity during the tax year, or $26,000 if the gift is made by both you and your spouse (and you are both U.S. citizens)
  • Amounts paid on behalf of any individual as tuition to an educational organization or to any person who provides medical care for an individual

A small number of states also impose their own gift tax.

Federal estate tax

Under the 2010 Tax Act, the applicable exclusion amount is $5 million in 2011 and 2012 (plus indexing in 2012), and the top estate tax rate is 35 percent. In 2011 and 2012, the unused basic exclusion amount of a deceased spouse is portable and can be used by the surviving spouse. In 2013, the applicable exclusion amount is scheduled to be $1 million and the top estate tax rate is scheduled to be 55 percent.

Note: Under the 2001 Tax Act, the federal estate tax was scheduled for repeal for one year in 2010. The 2010 Act reinstated the tax in 2010 with an applicable exclusion amount of $5 million and a top tax rate of 35 percent. An estate of a decedent dying in 2010 can elect to have the estate tax not apply, but a modified carryover basis would then apply instead of the step-up in basis.

Federal generation-skipping transfer tax

The federal generation-skipping transfer tax (GSTT) taxes transfers of property you make, either during life or at death, to someone who is two or more generations below you, such as a grandchild. The GSTT is imposed in addition to, not instead of, federal gift tax or federal estate tax. You need to be aware of the GSTT if you make cumulative generation-skipping transfers in excess of the GSTT exemption, $5 million in 2011 and 2012 (plus indexing in 2012), scheduled to be $1 million as indexed in 2013. A flat tax equal to the highest estate tax bracket in effect in the year you make the transfer (35 percent in 2011 and 2012, scheduled to be 55 percent in 2013) is imposed on every transfer you make after your exemption has been exhausted.

Note: Under the 2001 Act, the GSTT was scheduled for repeal for one year in 2010. The 2010 Tax Act reinstated the GSTT for 2010 with a GSTT exemption of $5 million, but applied a zero percent tax rate to GSTs in 2010. GSTT exemption should generally be allocated to generation-skipping trusts created in 2010 if the trust will have GSTs in years after 2010.

Note: The GSTT exemption is the same amount as the applicable exclusion amount for estate tax purposes in 2011 and 2012.

Some states also impose their own GSTT.

State death taxes

The three types of state death taxes are estate tax, inheritance tax, and credit estate tax, which is also known as a sponge tax or pickup tax.