Estate & Gift Taxes

Estate and gift taxes are imposed by the federal government and some states on the transfer of wealth to another individual. The distribution of wealth through lifetime gifts and transfers upon death are subject to a unified and cumulative tax. Lifetime gifts subject to tax are included in the donor's taxable estate so that the estate and gift tax applicable to such gifts is applied on a cumulative basis and the unified credit is applicable to each. Taxable estates and gifts are subject to a unified transfer tax. The tax rate applicable to estates and gifts is a progressive rate. Taxable gifts and estates are also provided a cumulative lifetime credit amount that increases each year to reflect inflation. This amount is a lifetime credit that will offset an individual's cumulative gift and estate tax burden dollar for dollar until the credit is completely exhausted. The benefits of graduated rates and the unified credit however are phased out beginning with cumulative transfers in excess of $10 million.

The gift tax is a tax on the transfer of wealth to another individual during the donor's lifetime. The individual who gives the gift, the donor, is primarily liable for the payment of any federal gift tax. If the donor does not pay the tax, the recipient of the gift, the donee, will be personally liable for the payment of the tax.

Certain gifts are exempt from taxation. Exempt gifts include gifts of a present interest worth $11,000 or less to any one individual in any one-year, gifts to a spouse, tuition or medical expenses paid on behalf of someone else, charitable contributions, and certain gifts to political organizations.

If a donor's gifts exceed the exemption amount, the donor must file a gift tax return. The gift however may not be subject to tax through application of the unified credit amount. The donor, assuming he has not previously exhausted the unified credit, would apply the unified credit amount to the tax on the gift with a resulting tax liability of zero. The only cost to the donor is a reduction of the unified credit amount available for future gifts or for use against estate taxes upon the donor's death.

The gift tax return is due on April 15 of the year following the date of the gift. A donor may apply for an automatic four-month extension to file the gift tax return but the date for payment remains April 15.

Whether an estate will be required to file a federal estate tax return depends on the value of the gross estate. In 2002 and 2003, an estate will have to file a return if its value exceeds $1,000,000. This amount increases to $1,500,000 in 2004 and 2005; to $ 2,000,000 in 2006, 2007, and 2008; and to $3,500,000 in 2009. A decedent's gross estate includes the value of all property in which the decedent had an interest at the time of death. Property would include such items as real estate, stocks and bonds, mortgages, notes and cash, insurance on the decedent's life, jointly owned property, certain transfers during decedent's life, powers of appointment, and annuities. If spouses owned property in joint tenancy, one-half of the value of the property in included in the gross estate of the first spouse to die.

The value of the decedent's property is its fair market value as of the date of death. Although the fair market value is easily identified for marketable securities or cash, it requires appraisals and other analyses to determine the market value of closely held businesses, real estate, personal property, and other non-liquid items. There are also special valuation dates and elections for special use property such as a farm or real property used in a closely held business that may result in a reduced valuation.

Once the gross estate is determined, certain items are deductible against the gross estate. The most noteworthy of these deductions is an unlimited estate tax marital deduction. The estate can pass tax free to a surviving spouse provided that the surviving spouse is a U.S. citizen and the surviving spouse's interest in the estate is not a nondeductible terminable interest. A nondeductible terminable interest is an interest in which a person other than the surviving spouse receives the right to possess or enjoy an interest in the property from the decedent upon the termination of the spouse's interest in the property.

The law provides certain permissible terminable interests that qualify for the marital deduction. A complex set of requirements applies but essentially the surviving spouse must have the right to all of the income from the property payable at least annually, no person may have the power to appoint any of the property to any person other than the surviving spouse during the surviving spouse's lifetime, and the executor must make an election on the U.S. estate tax return to treat the property as qualified terminable interest property.

Other deductions against the gross estate include certain administrative expenses, funeral expenses, claims against the estate, certain taxes and other indebtedness and charitable bequests.

The estate tax is based on the taxable estate plus taxable gifts made by the decedent. The progressive tax rates are applied to the total transfers subject to tax. The unified credit amount is then applied against the amount due reducing the total tax dollar for dollar.

The executor, personal representative, or person in possession of the estate's assets must file the estate tax return within nine months of the decedent's death. The estate can apply for a six-month extension of time to file, but the taxes must be paid within nine months of the decedent's death. The time for payment of the estate tax may be extended in certain circumstances.

The Tax Relief Act of 2001 phases out the federal estate tax by gradually increasing the amount of untaxed assets until 2010 and by repealing the estate tax completely in 2010. However, sunset provisions will bring the estate tax back unless Congress acts to extend the Act.

Some states also impose estate taxes. The state where the decedent resided may impose an estate tax, and states where real or tangible personal property is located may impose a tax as well. The law of each state with some connection to the subject property must be consulted to determine if any tax consequences associated with the transfer of wealth exist. An attorney skilled in taxation matters can help make that determination.

Form: Financial Planning

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Financial Planning

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