Everything You Need To Know About Estate Taxes And Gift Taxes

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The following is a post by MPFJ staff writer, Toi Williams, who is the professional personal finance blogger of Fine Tuned Finances. She has backgrounds in personal finance, sales, and real estate.

There are many people that would like to give monetary gifts to the people that are important in their lives or transfer their estate to their heirs upon their death, but are unsure how these actions will be affected by taxes.

The laws on estate and gift taxes are considered to be some of the most complicated in the Internal Revenue Code.  There are very specific rules and regulations that must be met for these assets to be transferred properly. 

Here is what you need to know about the estate tax and the gift tax:

What Is The Estate Tax?

The estate tax is the tax paid on the transfer of assets from a deceased individual to their beneficiaries.  Also known as an inheritance tax, the tax is assessed on large accumulated fortunes and inherited wealth. If the total amount of the assets to be distributed to the deceased’s heirs is larger than the amount designated as tax exempt by the IRS, the tax amount is assessed against the portion that falls above the exemption limit.  The tax is calculated before the assets are distributed.  Any amount that is disbursed to a spouse or to charity is exempt from taxation.

Estate Limits And Tax Rates

Most relatively simple estates do not require the filing of an estate tax return.  The tax rate and estate limits have varied throughout the years, and the levels have recently been reset to new limits by federal law.  Currently, the first $5 million in value of an estate is exempt from taxation.  This individual estate tax exemption can be effectively doubled for couples that are proactive with their basic estate planning.  The estate value in excess of the exemption amount is taxed at a rate of 35%.

How Are Estate Values Calculated? 

The estate value used for determining the amount of estate tax owed to the government is calculated using a very specific formula.  First, everything that the deceased owned or had certain interests in at the date of death is accounted for at fair market value.  This may be less or more than what was actually paid for the item when it was first obtained. The property included may consist of annuities, cash, insurance, securities, real estate, trusts, business interests, and other assets.  The calculated total of all of these items is considered to be the “Gross Estate” value.
Once the Gross Estate value has been determined, deductions can be taken to lower the total value of the estate.  These deductions generally include mortgages, certain debts, property that passes to charities or the surviving spouse, and administration expenses for the estate.  After all eligible deductions are taken, the resulting figure is the “Taxable Estate” value.  This is the value used to calculate the amount of tax owed.

What Is The Gift Tax?

The gift tax is a tax on the transfer of property between one party to another party while expecting to receive nothing, or less than the value of the original property, in return. The transaction is considered to be a gift if property (including money), the use of property, or income from property is given without expecting to receive something of at least equal value.  Selling something at less than its full value or making an interest-free or reduced-interest loan could be considered to be a gift.  The tax applies whether the donor intends the transfer to be a gift or not.
The gift tax imposes a tax on transfers of property during a person’s life, thereby preventing the avoidance of the estate tax should a person want to give away their estate to another party.  The person giving the gift is the one responsible for paying the tax, not the recipient. However, special arrangements can be made to allow the recipient to agree to pay the tax in place of the giver.  These types of arrangements are generally arranged by certified tax professionals in order to comply with IRS regulations.

What Gifts Are Taxable? 

Nearly any type of property or asset transfer can be considered a taxable gift.  However, there are some exceptions to the rule that allow you to give money or property without having to pay the tax.  Gifts that are generally excluded from taxation include tuition payments, the payment of medical expenses, and gifts to a charitable organization, a political organization, or a spouse.  There is also an annual exclusion limit and you will not have to pay taxes on gifts that fall under the limit.  The current exclusion limit is $14,000 per recipient for individuals and $28,000 per recipient for couples.

How Do They Affect My Federal Taxes?

Your federal income taxes are not ordinarily affected by making a gift of assets or property or by leaving your estate to your heirs.  Other than charitable contributions, you cannot deduct the value of the gifts that have been given from your taxable income.  A separate gift tax or estate tax return is filed with the IRS by the due date specified in the tax form instructions.  Gift tax forms must be filed by the end of the tax year while estate tax forms must be filed no later than nine months after the death of the deceased.
If you are not sure whether the gift tax or the estate tax applies to your situation, I strongly recommend that you visit with a tax practitioner who has considerable experience in this field.  For most small transactions, the services of a professional may not be needed, but transactions that are large or complex should be discussed with an attorney or CPA before you make a decision on how to proceed.  Many of the people that make gifts as part of their financial or estate plans enlist the services of these professionals to ensure that they do not run afoul of tax laws.
How about you all? Do you expect the gift tax or estate tax to affect your finances this year?  

Share your experiences by commenting below!

    ***Photo courtesy of http://www.flickr.com/photos/davidreber/4471416713/


    1. Yasmin E. Parsloe says:

      As much as a little extra change is warmly welcomed, I sure hope that everyone in my family remains healthy for a very long, long time. However, financial planning and insurance are something that we all have to plan for as the facts of life play out.

      My biggest question for you regards families abroad. For me, a lot of my close family lives abroad – whether it is Europe or Canada. Now, I understand that my family does have plans for the future as far as life insurance and wills, but does this mean the recipients will be taxed twice? For example, in England – I would be taxed an extortionate rate from the taxable income, and then once again when I move the money to the US.

      Is this a case where in order to avoid being taxed twice on this income, it would have to be transferred in increments less than $14,000?

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