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A Comprehensive Look at Estate and Gift Tax Laws

Estate Taxes and Gift Taxes.  What’s the difference between the two? In simplest terms, the Estate Tax is levied on money or property received from a person who has died. The Gift Tax is levied on money or property that is received from a living person.

Both have available exemptions, and the eligible minimum estate/gift values increase every year to compensate for annual inflation.

What Are the Estate and Gift Taxes?

Estate Tax

The Estate Tax is a tax on the transfer of property at your death. It includes the value of everything you own, or have interests in, at the time of death.

Gift Tax

The Gift Tax is a tax on the transfer of property from one individual to another without receiving the full value or any value of the property in return.  This tax can apply whether the donor intends the transfer as a gift or not.

Unified Credit

The unified credit gets its name from the federal gift tax and estate tax being integrated into one unified tax system.

History and Changes

Both the estate tax and gift tax laws have undergone many changes since their inception according to the needs of the Government or opposition to the laws themselves.

History of the Estate Tax

The Estate Tax was passed by Congress in 1916, three years after the introduction of the federal income tax. According to professor emeritus at Yale Law School and co-author of Death by a Thousand Cuts: The Fight Over Taxing Inherited Wealth, Michael Graetz, in an interview with Don Gonyea on Morning Edition: “Roosevelt supported the tax as an instrument for enforcing the equality of opportunity in the U.S. by making it more difficult to pass great fortunes from one generation to another,” Graetz says that the public accepted the tax as another progressive-era reform.

“It was the beginning of the progressive era,” says Graetz. “The income tax had just come in, in 1913. So, the public was very interested in progressive taxation, and the estate tax was a natural piece of that kind of system.” Significant opposition first appeared in the 1920s when Andrew Mellon of Gulf Oil tried to repeal the estate tax during his stint as secretary of the Treasury during the Coolidge administration.

Then, in the 1940s, Graetz says that opponents started labeling it the “death tax” in a bid to gain wider support for the repeal movement. The movement never succeeded. But the 1990s saw a resurgence in efforts to kill the tax, with an emphasis on how it affects family farms and small businesses.”

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History of the Gift Tax

The gift tax was first legislated in 1924, designed to be a protective measure to reduce income tax and estate avoidance. It was repealed in 1926 then rewritten and reintroduced in 1932. At its peak in 1999, it raised $4.6 billion in revenues, before the Economic Growth and Tax Relief Reconciliation Act of 2001.  This and more information on the Gift Tax can be found in OTA Paper 100, written by David Joulfaian.

How Is Each Calculated?

Estate Tax Calculation

Starting with the Gross Estate Value the following can be subtracted to give a Net Estate value for the estate’s tax purposes:

  • Debts and Expenses – including mortgages, lines of credit, personal loans, credit card debt, funeral expenses, and medical bills
  • Administrative Expenses – These are the expenses incurred to settle your estate and can include an attorney, accounting, and appraisal fees, storage and shipping fees, insurance, and court fees.
  • Charitable transfers – This can include direct gifts and property set aside in a Charitable Remainder Trust or Charitable Lead Trust.
  • Transfers to a U.S. Citizen Spouse -This includes transfers by the right of survivorship and transfers made to a trust.

From this calculated Net Estate value, subtract your available Federal Estate Tax Exemption; this will bring you to your taxable estate. Also note that if you’ve made any taxable gifts during your lifetime, then your available estate tax exemption will be equal to the difference between the total exemption available and the value of the lifetime gifts you’ve made.

Gift Tax Calculation

The amount owed for a gift tax is calculated by evaluating the fair market value of the gift and subtracting deductions. The IRS levies taxes equal to a percentage of that value. These can change annually but will sometimes total up to 45% of the value of the gift.

Exemptions for Both Tax Laws

Starting in 2013, the exemption for the Estate Tax was raised to $5 million; this is the amount an estate subtracted from the Net Estate Value. Any amount over that was then eligible for Taxes.  This amount has been raised yearly to compensate for annual inflation.

The Gift Tax exemptions are currently at $14,000 per year per person; this means you can gift up to $14,000 in money or property to as many people as you want within one fiscal year.

If you gift a person $15,000, the additional $1000 will be taxable. Most of the time, especially when the family is concerned, the exemptions and taxes are assessed together via the Unified Tax Credit. With the Credit, the IRS combines all the gifts you make in your lifetime with bequests from your estate.

The best example of this process was given by Julie Garber in an article for last March 2017 “If a father makes a one-time gift of $114,000 to his son for the purchase of a home, $14,000 of that gift is free and clear of the federal gift tax.

The remaining $100,000 is a taxable gift and would be applied to his lifetime exemption. But if the father gifts his son $14,000 in December, then gives him an additional $100,000 in January, the December gift is free and clear, and only $86,000 of the subsequent $100,000 counts against his lifetime exclusion – $100,000 less than the year’s annual $14,000 exclusion. Remember, the annual gift exemption is per person per year. You can give this much away to anyone person every single year and never dip into your lifetime exemption.

If the father doesn’t want to pay the gift tax on the $86,000 in the year the gift is made, he can reduce his lifetime gift tax exemption by this amount. Despite his significant generosity, Dad would still have about $5.4 million of the unified tax credit left to shelter his estate.

For most of us, the ability to give freely to our family and friends during our lifetime will not become an issue.  With an annual exemption of up to $14,000 per year per person tax-free as of 2017 and a $5+ million exemption that increases annually for inflation, these numbers will go a long way in protecting our finances and estates from qualifying for either of these taxes.

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