The Basics of Estate and Gift Taxes

Although most taxpayers are painfully aware of the income tax, many people are not aware that they can be subject to a tax on money or assets that they give as a gift, or money or assets that they leave as bequests when they die. The Internal Revenue Code refers to the taxes imposed on these transfers as the gift tax and the estate tax. Depending on the total amount of gifts that you make during your lifetime, combined with the size of your estate when you die, you may also be subject to these taxes. In addition, the year in which the gifts are made or in which a taxpayer dies also impacts these taxes.

The estate and gift tax may be minimized or avoided in a number of ways. The most widely used method applies what the Code calls the unified credit for gift and estate taxes. The Unified Credit allows a taxpayer to transfer, effectively tax-free, a certain credit-equivalent amount of assets via either gifts during life or bequests at death. For example, for tax years before 1998, the Code allows a unified credit of $192,800 against gift and estate taxes, which effectively allows taxpayers to transfer as much as $600,000 of assets tax-free through gifts and bequests.

The amount of the unified credit increases depending on the year in which the taxpayer dies. The table below provides the total value of the assets that can be transferred free of tax at death for the following years:

                   For estates                                          The value of assets that can
               of decedents dying in:                                 be transferred tax-free is:

1997 and earlier                                        $    600,000
1998                                                           $    625,000
1999                                                           $    650,000
2000 or 2001                                              $    675,000
2002 or 2003                                              $ 1,000,000
2004 or 2005                                              $ 1,500,000
2006 thru 2008                                          $  2,000,000

2009                                                           $  3,500,000

2010                                                                Repealed

2011                                                           $ 1,000,000

The gift tax exemption is $1,000,000 after 2002 and does not increase as the estate tax deduction noted above does. The gift tax is not repealed in 2010 and is indexed to inflation starting in 2010.

Keep in mind that married taxpayers can effectively double the amount of tax-free transfers through the use of certain estate planning techniques. This is due to the fact that both the husband and the wife qualify for the full unified credit exemption equivalent amount.

After reviewing the above credit amounts, you may reach the conclusion that the gift and estate taxes do not apply to you. However, many taxpayers do not realize the full value of their assets and unknowingly expose themselves to potential gift and estate tax liability.

Furthermore, if your existing estate plan is based on the pre-1998 unified credit of $192,800, it is important to review the estate plan in light of the increased unified credit amount that is available in tax years after 1997.

There are many ways to plan for your estate tax beyond the above. However, every individual has different assets, desires, etc. and no one plan is good for everyone. The idea is to plan and not let the ones you love have to face the loss of a loved one without a plan.  If you have any questions about gift and estate planning please contact us.

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