The United States has taxed the estate of decedents since 1916. The Gift Tax came into effect in 1932 and in 1976 Congress enacted the Generation Skipping Transfer (“GST”) tax and linked all three taxes into a unified Estate and Gift Tax. The Estate and Gift taxes are transfer taxes. They differ from the income tax in the sense that the income tax is a tax that is levied on income and capital assets that give rise to a taxable income because of earnings or sales. Of course, transfer taxes occur when a gift is made or when a decedent dies.

The Estate and Gift Tax only applies to the value of the transfer or assets that exceeds the Exemption level. The Tax Cuts and Jobs Act (“TCJA”) doubled the Estate and Gift Tax Exemption to $11.4 million for singles and $22.8 million for married couples. However, that Exemption amount only applies for 2018 through 2025. The Exemption level is indexed for inflation and 40% remains the top rate for Estate and Gift Taxes.

Over the last two decades, the tax rates and Exemption levels have varied extensively. Up to 2001, the Exemption level was set at $675,000 and scheduled to gradually increase to $1 million. The Exemption level was increased dramatically over the past several years and finally the TCJA doubled the existing $5 million credit to $11.4 for singles and $22.8 for married couples. However, this provision sunsets at the end of 2025 so in 2026 [as the way the law is presently written]. The Exemption level goes back down to $5 million increased by inflation. The tax is imposed on all assets of the decedent and whenever anyone makes a gift.

What Is The Gift Tax?

In 1932, Congress enacted the Gift Tax. The purpose was to prevent donors from avoiding estate tax by transferring their wealth before they died.

The tax currently provides a lifetime Exemption of $11.4 million in 2019. This Exemption is the same unified credit that applies to the estate tax and is integrated with it. Beyond that Exemption, Donors pay gift tax at the estate tax rate of 40%.

Each year an additional amount is also disregarded for Gift and Estate Taxes. The 2019 $15,000 annual exclusion is granted separately for each recipient. Thus a married couple with three children can give the children a total of $90,000 each year ($15,000 for each parent to each child without reducing the parents’ lifetime unified credit). The receipts are not taxable to the recipient. Any gifts made by non-resident aliens outside of the United States are not taxed either to the donor or the donee.

Estate (Death) Tax Explained

Within 9 months of the person’s death, if that person’s gross estate exceeds the Exemption amount, the executor must file a Federal Estate Tax Return (IRS Form 706). The estate tax applies to a decedent’s gross estate which generally includes all of the decedent’s assets both financial (like stocks and bonds) and real (like real property and other tangible properties). It also includes a decedent’s share of jointly owned assets and life insurance proceeds from policies owned by the decedent. In addition, it takes into account reportable gifts which of themselves require a Gift Tax Return.

Fortunately, the Estate and Gift Taxes allow an unlimited deduction for transfers to a spouse or to charity. Estates may also deduct debts, funeral expenses, administrative and legal fees, charitable bequests and estate taxes paid at the state level. The taxable estate equals the gross estate less deductions. In 2019, the credit equivalent effectively eliminates a large portion of the estate tax up to $11.4 million so that none of that unified credit is used up by prior gifts. Any value over the $11.4 million Exemption is generally taxed at the top rate of 40%. It should be noted that the Exemption level is portable between spouses making the Exemption for married couples double the Exemption for singles. For example, if the first spouse to die bequests $2 million to children and grandchildren, the survivor’s Exemption would be increased by the unused $9.4 million of the Exemption credit.

There are special provisions reducing the tax or spreading the payments over time for family owned farms and closely held businesses. One of the important factors of estate tax is that the tax basis of assets in the estate is stepped up to the value at the time of death meaning that unrealized capital gains on assets held until death are not subject to capital gains tax. For example, suppose that an individual purchases property for $1 million and that when the individual dies the property is now worth $3 million. This would normally produce a capital gain of $2 million if sold. However, because of the step up of the tax basis of the asset at the time of death being increased to the value at that time, the capital gain is eliminated. If the beneficiary receives the $3 million asset with the $2 million gain from a decedent, that $2 million gain goes away because the basis for tax purposes is increased to the fair market value or $3 million. This forgiveness of capital gain is famously called by journalist Michael Kinsley “the angel of death loophole”.

Generation Skipping Transfer Tax (“GST”)

Congress enacted the GST in 1976 to prevent families from avoiding the estate tax for one or more generations by making gifts or bequests directly to grandchildren or great grandchildren. The GST effectively imposes a second layer of tax (using the Exemption and the top tax rate under the estate tax) on wealth transfers to recipients who are two or more generations younger than the donor.

Conclusion

As was previously stated, the Exemption level sunsets at the end of 2025 and is presently set to revert back to the $5 million plus index inflation beginning in January of 2026. The IRS has recently ruled that there will be no claw back at that time which means that gifts made before 2026 can be transferred using the increased credit without any worry that if the Exemption is reduced back to the $5 million amount (indexed), the donor will not be penalized and the amount of the Exemption at that time of the gift will prevail.

For more information on Estate, Gift & Generation Skipping Transfer Taxes, an initial consultation is your next best step. Get the information and legal answers you are seeking by calling (714) 384-6500 today.