Federal Gift and Estate Taxes

Gift and Estate TaxesThe money or property that you own when you die (also known as your “estate” or “gross estate”), may be subject to federal estate taxes and some form of state death taxes. It’s wise to understand these taxes and how they might apply to your situation. This is more true since the passage of the Economic Growth and Tax Relief Reconciliation Act of 2001, or the 2001 Tax Act. As with any new tax laws, this law may make life more complicated and uncertain.

Prior to the 2001 Tax Act, no gift or estate taxes were imposed on the first $675,000 of combined transfers of capital during life or at death. At that time, the tax rate tables were simple, as the same rates applied to gifts made and property owned by persons who died in 2001. And, like income tax rates, the gift and estate taxes were graduated according to the amount of gifts offered. Under this system, the recipient(s) of a lifetime gift received a carry-over basis in the property received and the recipient of a bequest got a step-up in basis based upon fair market value of that property on the date of the death of the person who made the bequest – not necessarily what that the person paid for them or what their values were when you acquire them.

When the 2001 Tax Act was enacted, it increased the applicable exclusion amount for gift tax purposes to $1 million. The top gift tax rate is 45 percent in 2007 through 2009, and 35 percent in 2010. The 2010 rate is the highest tax rate under the 2001 Tax Act, and the carry-over basis rules remain in effect throughout this time frame.

Despite this increase, many gifts can be made tax free, including gifts to a U.S. citizen spouse or up to $128,000 in 2008 tax free to a noncitizen spouse. Gifts to qualified charities also are tax free as are gifts totaling up to $12,000 to any one person or entity during the tax year or $24,000 if the gift is made by both spouses (if U.S. citizens).

Gifts also can be paid on behalf of any individual as tuition to an educational organization, such as a grandparent paying a portion of a grandchild’s college tuition. Also, tax-free gifts can be made to any person who provides medical care for an individual. Other items that can reduce an estate tax include:

  1. Marital Deduction: One of the primary deductions for married decedents is the Marital Deduction. All property that is included in the gross estate and passes to the surviving spouse is eligible for the marital deduction. The property must pass “outright.” In some cases, certain life estates also qualify for the marital deduction.
  2. Charitable Deduction: If the decedent leaves property to a qualifying charity, it is deductible from the gross estate.
  3. Mortgages and Debt.
  4. Administration expenses of the estate.
  5. Losses during estate administration.

Under the 2001 Tax Act, the applicable exclusion amount for estate tax purposes increases in steps until it reaches $3.5 million in 2009; however, the applicable exclusion amount for gift tax purposes remains fixed at $1 million. Top estate tax rates are 45 percent in 2007 through 2009. The estate tax (but not the gift tax) is repealed in 2010, but the estate tax applicable exclusion amount and rates revert to pre-2001 Tax Act levels in 2011. So, if you want to save money on taxes, then 2011 would be a great year to die.

When the estate tax is repealed in 2010, the basis rules will be changed to those similar to the gift tax basis rules. The step-up in basis rules return in 2011.

Most relatively simple estates (cash, publicly traded securities, small amounts of other easily valued assets, and no special deductions or elections, or jointly held property) do not require the filing of an estate tax return. A filing is required for estates with combined gross assets and prior taxable gifts exceeding $1,500,000 in 2004 – 2005; $2,000,000 in 2006 – 2008; and $3,500,000 effective for decedents dying on or after January 1, 2009.

Finally, 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, which is $2 million (through 2008). A flat tax equal to the highest estate tax bracket in effect in the year you make the transfer is imposed on every transfer you make after your exemption has been exhausted.

For more information, visit the IRS site and look through the various topics listed under estate and gift taxes.

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