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How Federal Estate and Gift Taxes Work

Many people are concerned that a significant portion of their estates will be consumed by federal estate tax. Federal estate and gift taxes are really a single tax on the value of property transferred from one person to another. The gift tax applies to transfers during life and the estate tax to transfers on death. Estate and gift tax rates are high. However, very few gifts and estates are actually taxed because of generous exemptions, exclusions, and deductions.

The Estate Tax

Lifetime Estate and Gift Tax Exemption

Each individual is entitled to transfer a certain dollar value of property without any estate (or gift) tax liability. The Tax Cuts and Jobs Act of 2017 doubled the estate tax exemption to approximately $11 million. The exemption is indexed for inflation and is expected to rise each year. In 2025, the exemption will be cut in half to its 2017 level unless Congress enacts a new law. The amount of the exemption is reduced by any taxable gifts you have made during your life. Because of the exemption, less than .1 percent of estates will be subject to estate tax. That translates into fewer than two thousand estates per year.

Property Included in Your Estate

Your estate consists of everything you own at the date of your death. Included in your estate are real estate, cash, stocks, bonds, annuities, businesses, and life insurance policies that you own. All assets you own are included whether they must pass through probate or not.

The value of your estate is the fair market value of each asset on the date of death or on the alternate valuation date, six months after your death.

Property Not Included in your Estate

Generally, your estate does not include property owned solely by your spouse or other individuals. Lifetime gifts over which you have retained no powers or other control are not included (but taxable gifts will reduce the amount of the lifetime exemption available to your estate).

Estate Tax Deductions

The value of your estate is reduced by the following deductions.

  • Marital deduction. All property included in your estate that passes to your surviving spouse (provided he or she is a U.S. citizen) is eligible for the marital deduction. Although the property must pass “outright,” some life estates and trusts qualify for the marital deduction.
  • Charitable deduction. If you leave property to a qualifying charity, it is deductible from your gross estate.
  • Mortgages and debt.
  • Administration expenses of the estate.
  • Losses during estate administration.

The Gift Tax

The Annual Gift Tax Exclusion

Most gifts are not subject to gift tax because of the annual exclusion. The annual exclusion allows you to give away gifts up to a certain value to an individual tax-free each year. The amount of the annual exclusion is $15,000 for gifts in 2021. Like the lifetime exemption, it is also indexed for inflation. You can give away gifts up to the annual exclusion to as many people as you like. For example, if you have three children, you can give each child $15,000 a year (a total of $45,000) without making a taxable gift. You and your spouse are each entitled to an exclusion, so together you can double the amount of the gift to each person without any tax liability.

The amount of any gifts you make above the annual gift tax exclusion counts against your lifetime estate and gift tax exemption. Even if you don’t owe any tax on such gifts, you still need to file a gift tax return.

Other Gifts not Subject to Gift Tax

In addition to gifts worth less than the annual exclusion, the following gifts are not taxable gifts.

  • Tuition or medical expenses you pay for someone, but you must pay them directly to the educational institution or health care provider.
  • Gifts to your spouse.
  • Gifts to a political organization for its use.
  • Gifts to qualifying charities.

If you expect your estate to be subject to estate tax, I am happy to meet with you to discuss strategies for minimizing tax liability. Even if your estate will not owe estate tax, I can assist you with other estate planning goals, such as probate avoidance, providing for minors and other dependents, and planning for your own incapacity.

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