Estate Planning 101: the Gift Tax Exclusion

If you’ve never heard of estate planning then you probably don’t need it.  But if you’re curious (and I daresay you should be) then read on.  Estate planning is simply the act of manipulating your money so that you pay the least amount of taxes when you die.  Why should you care?  Because if you have money or other property to leave after you die, you care whether your heirs get taxed and how much.  You want them not to be unnecessarily taxed, so you plan your estate accordingly.  One of the basic components of estate planning is the gift tax exclusion.

What’s the Gift Tax Exclusion?

The IRS lets you give away money each year up to a limit, tax-free.  In IRS language, a gift is when you give property and expect nothing in return.  It can also mean when you sell property for such a low price it’s like giving it away.  Property, by the way,  means money, real estate, whatever you have of value.

You can give away $14,000 a year and not pay any taxes on it.  This is called the gift tax exclusion.  It’s $14,000 for 2013 and goes up each year to adjust for inflation.  When you give away the money, you don’t have any control whatsoever over that money anymore.  It’s a true gift to whomever you want: friends, relatives, charities, you name it.  Gifts to your spouse don’t even count.  You can give it all to your spouse and there’s no gift tax exclusion amount at all.

The gift tax is estate planning 101.  By gifting your money, you’re reducing the amount of your estate.  Smaller estate = smaller estate taxes.  This is transfer of wealth, which is what wealthy people do a lot of, in order to try and pay as little tax as possible.  This is the job of financial advisers, by the way.  They help people manage their wealth so as to preserve it and keep it from the IRS.

The Gift Tax Exclusion Only Goes So Far, Doesn’t It?

You can give and give and give up to the gift tax exclusion amount but if you’re truly very wealthy this will only reduce your estate by a comparatively piddly amount.  Just think: $14,000 for ten years and you haven’t even give much away at all.

But there’s this thing called the lifetime exclusion amount, or gift tax lifetime exemption.  You can exceed the gift tax exclusion all you want up to a certain amount of money.  That has been set at $5 million!  Once you go over that amount you’ll start paying the gift tax.   Just keep a running tab with the IRS so they and you know when you’ve used up your lifetime exclusion.  Use IRS form 709 for that. IRS Tax Refund



Good Times for Estates

President Obama endeared himself forever to wealthier taxpayers when he signed into law the American Taxpayer Relief Act in 2012.  This set permanently the federal estate tax exemption amount to $5 million, adjusted annually for inflation.

Back in 2000, the federal estate tax exemption was $675,000.  With inflation, that figure is and was more and more attainable for estates.  As a consequence, people were getting hit hard with such a low federal estate tax exemption.  Now, thanks to the American Taxpayer Relief Act of 2010, the exemption amount is significantly higher than it had been for years  Far fewer estates fall under taxation beginning in 2012.

That’s good news, and here’s some more: the federal estate tax rate has been falling.  Let’s go back to that dismal year for estates: 2000.  The top estate tax rate was 55%.  Now the top estate tax rate is 40%.

The Federal Estate Tax Exemption is Permanent: What Else?

The American Taxpayer Relief Act also made some other things permanent.  One is something called portability.  When a wealthy person (here, let’s define “wealthy” as someone who has more than the federal estate tax exemption amount, $5.25 million) the fate of his or her fortune largely depends on whether or nor he or she was married.

That’s because the federal estate tax exemption doesn’t count when the heir is the spouse.  He or she can leave all of the fortune to the spouse with no federal estate tax at all.  Even if it’s beyond comprehension to most people: $20 million.  No tax at all.  But when the surviving spouse dies, federal estate taxes will be imposed.

Now, when the first spouse dies and leaves everything to the surviving spouse, he or she didn’t make use of the federal estate tax exemption.  In that case, that $5.25 million exemption amount (for 2013) gets transferred with the money.  Then, when the surviving spouse dies, she gets double the federal estate tax exemption amount.  She can leave $10,5 million to heirs and not pay any federal estate tax.  That’s called portability.

The American Taxpayer Relief Act of 2012 made permanent the idea of portability of the unused exemption amount between spouses.  Before the Act, the idea of portability, the federal estate tax exemption amount, and more were all over the board, changing every year never fixed.  It made estate planning more complicated than it really needed to be.  To make use of portability, IRS Form 706 must be filed when the first spouse dies.

The New Federal Estate Tax Exemption is Good News

What all this means is that dying rich is easier than ever.  It’s the best conditions ever, in the history of our federal estate tax, for transferring wealth.  There are ever more wealth-transfer options not even mentioned in this article, such as Grantor Trusts, an increased Federal Gift Tax exclusion amount, Generation Skipping Transfer Trusts, and all sorts of trusts, which shelter enormous wealth beyond the combined $10.5 million federal estate tax exemption amount.  All in all, I’d say it’s a good time to leave money to your heirs.



Inheritance Tax vs. Estate Tax

When someone dies and leaves money (or property) to an heir, that’s income for the heir.  As we already know, money doesn’t really change hands in any large quantities under our tax system unless Uncle Sam gets a little bit of the pile.  The IRS will levy an estate tax on a deceased person’s estate, but some states will also levy an inheritance tax on the heir.  Double whammy!

The Inheritance Tax is for Heirs

So, the estate tax is for the estate and the inheritance tax is for heirs.  Isn’t this double taxation: the same chunk of money being taxed twice, once as it leaves the estate and then again as the heir receives it?  Well if you are the heir then you are only paying the Inheritance tax, not the estate tax.  Also, the Inheritance tax goes towards your state and the estate tax goes to the IRS.

Sometimes the person drawing up the estate will put directions in his or her will: the estate should pay any Inheritance taxes for the heirs, if there are any.  That’s to prevent a situation where an heir can’t pay the inheritance tax on a large piece of property and is forced to sell the property in order to pay the Inheritance tax.

Not All States Have an Inheritance Tax

Well that’s a relief for most of us.  What states have the inheritance tax?  As of 2013, here’s the unlucky list:

  • Oregon
  • Washington
  • Vermont
  • Minnestoa
  • New Jersey
  • Maryland
  • Maine
  • New York
  • Ohio
  • Connecticut
  • Delaware
  • Hawaii
  • Massachusetts
  • Washington D.C.

Now, the Inheritance tax is different state by state.  There’s a threshold amount, under which the heir pays no death tax.  This is called the Inheritance tax exemption.  In some states that threshold is lower than others, meaning the heir pays more taxes.  New Jersey, for example, has a Inheritance tax exemption of $675,000, meaning the Inheritance tax kicks in much sooner than say in Hawaii where the Inheritance tax exemption is $5,250,000 and is indexed for inflation.

A large number of states who have the death tax (that’s what opponents of the inheritance tax call it, by the way) have an Inheritance tax exemption of one million dollars.

Are There Any Inheritance Tax Exceptions?

Yes, spouses are immune, they are the exception to the rule.  If a spouse inherits money or property then he or she doesn’t pay any inheritance tax, just like the Federal estate tax rules.

Another exception to the inheritance tax rule is children, in some cases.  They are exempted from the Inheritance tax sometimes.  Sometimes they aren’t exempt but they pay only on a portion of the inheritance.




Can You Avoid the Estate Tax With the Gift Tax?

So, you want to give away some of your assets.  Maybe your grandchildren could use some cash.  Maybe your daughter and son-in-law need a down payment for a house.  Maybe you want your heirs to enjoy their inheritance now, before you leave this good earth.  Regardless of your reason for giving away cash, property, or any other personal asset, the IRS wants a piece of the action.  They cover this nicely with what’s called the Gift Tax.

A gift is any time you give property away with no expectations of getting anything in return.  It’s also considered a gift if you sell something to someone at a hugely discounted price, one that’s obviously a nominal amount.

What is the Gift Tax?

You may have noticed that any time money changes hands, there’s a way for the IRS to get some of it.  Think about it: sales tax: when something is sold, money changes hands.  The IRS gets a bit.  Selling a house?  If you make over a certain amount in profit, you’ll also be giving some to the IRS.  Well it’s the same for giving away property (property means cash, real estate, stuff…).

The gift tax is the IRS’s way of disallowing people the option of avoiding the estate tax.  The estate tax places a tax on property that’s inherited when someone becomes deceased.  So, the elderly, with the help of estate planners in some cases, give away money before they die so as to avoid the estate tax.  But you can only give away a certain amount before the gift tax kicks in.

How the Gift Tax Works

Well you’re allowed a certain amount before you get hit with the gift tax.  Each year or couple of years that amount goes up a bit, to keep up with inflation, or when Congress changes the tax code to hopefully more fairly tax the American people.  The certain amount you’re allowed is called the gift tax exclusion because there’s a certain amount that’s excluded from taxation.  For four years from 2009 to 2012 the amount you could give away and not get hit with the gift tax was $13,000.

The 2013 gift tax exclusion amount is $14,000.  For the past ten years, when the exclusion amount did go up, it went up by $1000.  For more details on the Gift Tax (and the Estate Tax) see IRS Publication 950, Introduction to Estate and Gift Taxes.

How to File the Federal Gift Tax Return

It’s IRS form 706, available on the IRS website or for most people doing their taxes with tax preparation software, it’s built into the program.  If you take your taxes to someone to have athem done for you, they’ll ask you if you received any gifts…don’t tell them what you got for your birthday!  They’re asking you if they’re going to need to fill out form 706 and possibly declare having received property, thus having to pay the Gift Tax.


Money refund

The Great Estate Tax Exemption Debate

It’s My Money!

Families with fortunes pay great attention to the estate tax exemption because it determines how much of their wealth they’ll be able to keep from generation to generation. The rich would like to be able to hand down their massive fortunes to their heirs and not be bothered by the IRS, who wants to tax the heck out of these fortunes.  Their thinking is, It’s private money, why should the IRS get it?

The Federal Government Needs Money

On the opposite side of the estate tax exemption debate are many Democrats and groups like the Americans for a Fair Estate Tax (AFET), YWCA, United for a Fair Economy, the Responsible Wealth Project, the AFL-CIO and several other large union groups.  They argue that the super rich should finance the repair of the nation’s budget problems.  They don’t want to see Social Security and Medicare cut, which is a common proposal for fixing the budget.

They see the estate tax exemption as a way to prevent the concentration of wealth in the hands of just a few super rich families.  That’s partly what our government is all about, according to them.

The Estate Tax Was Never Meant to be Permanent

Others who pay attention to the estate tax exemption are members of Congress who campaign year after year for what they think is the best way to deal with large estates and taxation.  Also on the side of the super-rich, who want to see the largest estate tax exemption possible, or some who even want the entire estate tax repealed, are conservative groups like the 60 Plus Association.

They claim that the original estate tax, enacted in 1797 for just five years, was meant to be temporary to finance a Navy to fight against France.  It was called the Stamp Tax back then.   It was enacted again for the Civil War and again for World War I.  Then at the end of World War I it was never repealed and estate tax foes claim now’s the time to correct that mistake.  In order to drive home their point that the estate tax is a bad thing, they have dubbed it the Death Tax.

Foes of the estate tax also claim that it discourages the accumulation of wealth, which hurts the economy.  Let the super rich keep their money so they’ll keep on making it, which is what keeps our economy going, seems to be their philosophy.  The estate tax exemption has a lasting effect on the longevity of small family businesses, the backbone of our economy.  In the past, it also had a strong effect on farms, which used to be the backbone of our economy.

The Estate Tax Prevents Plutocracy

Proponents of the estate tax also see the accumulation of wealth from generation to generation as a risk.  A risk of plutocracy, which is the concentration of wealth in the hands of a few businessmen who head family businesses and who use their wealth to influence the government and exert political power without ever having run for office.  For this group, the estate tax and a low estate tax exemption are a way to balance inequalities of wealth.

We Can Get Rid of it or Change the Estate Tax Exemption

Getting rid of the estate tax altogether is a radical move.  Instead, lawmakers in the past have preferred to monkey around with the estate tax exemption limit.  That is, they raise or lower the amount of money that’s exempt from being taxed.  This was almost set to be as low as $1 million in 2012  but instead was set at $5.25 million.  This is the highest the estate tax limit has ever been.  Consider also that the estate tax exemption limit is doubled for married couples.  A couple can bequeath $10.5 million before they pay any tax on that amount.

For now, this is the current compromise.  Thanks to a relatively high estate tax exemption amount, the rich can leave a substantial amount of money to heirs before they are hit with the “death tax”.  But there is still a death tax, it hasn’t gone away yet.

Businessman in front of private jet

The Estate Tax for 2013 Lets More Off the Hook

If you find yourself having to worry about the Estate Tax in 2013, then you can stop worrying…unless you’re extremely wealthy.  And let’s just be clear here from the get-go: extremely wealthy means you have an estate that’s worth over $5.25 million.  The rules have changed for the better and the IRS has been generous, at least in this one area of taxation.

Federal vs State Estate Taxes

As an individual, you can now leave up to $5.25 million when you die, without taxation from the IRS.  That doesn’t mean your state government won’t tax you on it, though.  It varies state by state what happens, tax-wise, to your estate.  And also keep an eye on what your state does with the inheritance tax, which is really a tax on the same money but on the receiver, not the giver.  And a few unlucky estates will be subject to both estate taxes and inheritance taxes: Maryland and New Jersey, for example, will hit you both coming and going on the taxes.

Federal Estate Tax for 2013

What estate planners had been facing at the end of 2012 was a pretty sad fiscal cliff situation: the exemption amount for the estate tax was going to drop down to $1 million.  There are a lot more millionaires out there than there used to be, so a lot of people were going to be hit with the estate tax in 2013 if nothing had been done in Congress.

But luckily the tax code was changed to install a permanent exemption amount of $5.25 million.

Estate Tax Rate for 2013

The other Fiscal Cliff issue that had estate planners worried for their clients was the actual rate of the estate tax.  The rate was going to be 55%!  But again, we can all breathe a sigh of relief because the top rate for the Estate Tax for 2013 is 40%.

What all this means is that wealthy clients are able to pass their wealth on to the next generation without the IRS taking more than half of it away.  Couples can will double the 2013 exemption amount: $10.5 million to their heirs, tax free (at least from the IRS).

Gifting to Avoid the Estate Tax

Individuals can give money away each year to whittle down their estates: if you are in danger of exceeding the $5.25 million exemption amount then consider gifting.  You can gift up to $14,000 per person in 2014, tax free.

The other way to avoid some estate tax is to create a trust.  Definitely something you want to talk to a professional about.

But for now, unless you are extremely wealthy ($5.25 million or over), you won’t have to worry about all this because the IRS has changed the rules forever starting with the estate tax for 2013.  For more information form the IRS on the Estate and Gift taxes, see Publication 950 here.



Good News for the Estate Tax: From 2012 on, the $5 Million Exemption is Not Disappearing!

A little while ago, when the nation was about to fall off the fiscal cliff, a lot of money and tax bloggers warned that the estate tax in 2012 was the last of its kind.  Among many other thing that were set to expire at the end of 2012, there was the $5 million exclusion for estate taxes.  That is, estates worth less than five million dollars were exempt from having to pay estate tax.

After you die, your property goes to your heirs, whom you designate in your will.  This property (the term property includes everything, from cash to actual property) is taxed on the federal level.  Some states also tax it but that’s a different matter.  It’s called the estate tax.

You can try and avoid the estate tax by giving away your money or property before you die.  But then you get hit with the gift tax.  Either way, the IRS has its share.  But not always!

Gift Tax & Estate Tax Exemptions

There are limits and boundaries between your gifts and your estate and the IRS.  In other words, you can give away some money without being taxed by the IRS.  You can also leave some property to your heirs without the IRS taking its share, too.  These are called gift tax exemptions and estate tax exemptions.

At one time, the federal estate tax was eliminated!  That was a nice year to die, it has been said.  The year was 2010 and it was the Economic Growth and Tax Relief Reconciliation Act of 2001.  Why it took nine years to take effect is just something about the way politics work.  Things take time to change.  But once that nice break came to be, it went away almost immediately.  The elimination of the estate tax lasted only one year, and then in 2011 it was back.  But it was a nice $5 million, which exempted lots more people from tax than the $2 million exemption limit of 2008 or the $3.5 million level of 2009.

Why The Estate Tax in 2012 Was Significant

What the exemption amounts are to be every year, was the heart of the matter for many estate tax bloggers at the end of 2012.  You see, there was a real possibility that the nice fat $5 million exemption on estate taxes would revert to a much lower number.  Many more people would be facing a lot more in taxes.  There was a fear that the exemption limit would go back to the rate it was in 2003: $1 million.  Bloggers had sore fingertips from all the dramatic blogging they were doing about this horrible possibility.  They also liked to link to financial planning affiliates, conveniently nestled amongst the scare tactic phrases like plan your estate before we fall off the fiscal cliff and you lose all your money!

Anyhoo, the exemption limit did not revert to the paltry $1 million and it’s safely being held at $5,120,000 for 2012 and even higher for 2013.  We can all relax, now that we will be able to leave more millions to our heirs without taxation from the IRS.

For more information on the Estate Tax, go directly to the source, the IRS.  Here’s their web page on estate taxes.


Senior man standing outside house

How the Estate Tax Works

When you die, your possessions will go to somebody or to some organization.  We all know what a will is for, and most of us manage to leave some sort of will, whether it be drawn up in a lawyer’s office or written on a paper napkin from a diner, made legal by your signature.  Whatever form it takes, your will directs those you’ll be leaving behind on how to distribute your property after you go.
Sometimes we have very little, or just enough to pay the bills, or nothing at all.  If you are leaving lots behind, the IRS requires you to file an estate tax return.  Your estate is the total of everything you leave behind.

Here’s the basic formula for figuring estate tax:

(Assets – Adjustments) + Taxable Gifts = Taxable Estate

The Estate Tax Works Like Income Tax

The total of everything you leave behind is called your Gross Estate. This includes of course your money, but also your real estate, your investments, any businesses you own or partly own, securities, trusts, and even any insurance you carried at time of death.  It includes the items in your home, right down to your silverware.  The value of your things is based on fair market value, which is what they’re worth if you were to sell them at the moment.  Sometimes that’s literally what will happen- things may be auctioned off to pay bills, or your heirs may decide to sell things if they don’t want them.

How to Figure Your Taxable Estate

Just like figuring your income tax, you take the grand total of your assets and subtract from that certain deductions and other adjustments.  That’s how you arrive a your taxable estate.  Examples of things that will reduce your gross estate are bills, property (assets) that were willed to your heirs, that isn’t taxed.  Things you leave to your surviving spouse are tax-free for the most part.  Or things you donate to charities are not taxable either, so they are not part of your taxable estate.  Just like income tax.

Then you have to add something to the number you got for the taxable estate:  gifts you gave to people over your life, that are taxable.  Now you have a final number, from which you will figure your estate tax.  The IRS has an estate tax page that outlines everything you need to know.



Map of States where there is no Estate Tax


For the SuperRich Only: Federal Estate Tax

What happens to your stuff after you die?  I don’t mean just your sofa and your cd collection, but also your bank accounts, your retirement fund, and any other financial holdings you had before you passed on.  Well, when you die, what’s left of your assets are combined into your estate.  Hopefully you made a will and named a person as executor of your will.  That person is in charge of making sure your assets are distributed the way you spelled out in your will.  The executor also sees that your bills are paid, as well as your taxes that you may have owed at time of your death.

There is another type of tax that will become important after you die- and it’s the tax your heirs will pay on the money you leave them.  It’s called the estate tax.  Let’s see how your heirs will fare when they’re faced with inheriting money.

What is the Federal estate tax?

The IRS is always interested in income, and an inheritance is no exception.  Let’s shift our focus from the deceased toward the living, who will inherit parts of the estate.  Heirs will face estate tax if they inherit over a certain dollar amount. This dollar amount is called the basic exclusion limit.  Anything up to the limit is not subject to an inheritance tax, aka estate tax.

What’s the Basic Exclusion Limit?

The 2012 Basic exclusion limit for federal estate taxes is $5.12 million.  Yes that’s right you can inherit up to 5.12 million dollars and not pay estate taxes.  Anything over that amount, however, is taxed at a pretty high tax rate.

Each year the IRS adjusts the basic exclusion limit for inflation.  In 2013, the limit will go up to $5.25 million.  Anything over that is taxed at 40%.

Now You Understand Why There’s Estate planning!

For wealthy families, this limit is pretty low and they have to worry about estate taxes on huge fortunes.  Therefore, there is a practice called estate planning, whereby an expert tax accountant or adviser helps the family come up with a plan to avoid that nasty 40% rate on money over the exclusion limit.

Usually estate planning comes in the form of gifting the money to family or friends before death.  You can give cash gifts to anyone you like and as long as it’s under a certain dollar amount, it won’t be taxed.  That amount is $14,000 and the tax is called a gift tax.

Well if you’re worrying about a $10 million fortune it’s going to take many many years to give it all away at $14,000 per year!  So there are other vehicles for avoiding having to pay too much estate tax.  One of these is the marital deduction.  A spouse can will his or her entire fortune to his dearly beloved and he or she won’t pay a penny in estate taxes.  It’s basically an unlimited deduction.  The only stipulation is that the surviving spouse must be a U.S. citizen.

When that surviving spouse is getting ready to pass the inheritance along, if there is unused portion of that original inheritance left it can be combined with his or her own personal $5.12 million exclusion for a combined $10.24 million in 2012 that’s not going to be taxed by the IRS.