November 2nd, 2020

Breaking Down the Federal Estate Tax and Federal Gift Tax

A common estate planning matter is addressing the difference between the federal estate tax and the federal gift tax. What are the tax implications of each on your plan?

What is the Federal Estate Tax?

The Federal Estate Tax is a tax imposed against the value of your taxable estate upon your death. It is collected by the IRS.

Is my entire Estate subject to the Tax?

No. The federal tax laws allow a certain amount of your Estate to be exempt from the Federal Estate Tax. This number is known as the basic exclusion amount. If you die in 2020, the basic exclusion amount is $11,580,000. If you die in 2021, the basic exclusion amount will be $11,700,000. This amount will be subject to a cost-of-living adjustment each year. It will increase every year through 2025.

What happens after 2025?

After 2025, the basic exclusion amount is scheduled be reduced to half the amount of 2025, and then subject to an annual cost-of-living adjustment. For example, if the basic exclusion amount is $12,200,000 for 2025, then the basic exclusion amount for 2026 will be $6,100,000 plus the cost-of-living adjustment that is applicable for that year.

What is the rate for the Federal Estate Tax?

If the net assets of a decedent’s Estate are worth more than the basic exclusion amount, the excess amount will be subject to a tax rate of forty percent (40%). However, this tax does not apply for any assets given to a surviving spouse or a charity.

How many people are subject to the Federal Estate Tax?

The most recent statistics from IRS reflect Federal Estate Tax Returns (IRS Form 706) that were filed in 2016. For that year, the basic exclusion amount was $5,450,000. In 2016, the United States reported a total of 2,744,248 deaths. For that year, the IRS received 5,467 returns for decedents that owed any Federal Estate Tax. Therefore, less than 0.2% of decedent’s Estates in 2016 were subject to the Federal Estate Tax.

What is the Federal Gift Tax?

The Federal Gift Tax is a tax that is designed to prevent people from giving away their entire net worth and avoiding the Federal Estate Tax.

Are all gifts taxable?

No. Every year, you are allowed to give gifts to individuals with no tax consequences as long as the gift received by each individual is less than the annual exclusion amount.

What is the annual exclusion amount?

For 2020 and 2021, the annual exclusion amount is $15,000. This amount is subject to periodic cost-of-living adjustments.

What happens if I give more than the annual exclusion amount?

If you give more than the annual exclusion amount to any person (other than your spouse or a charity), you must report that gift on a Federal Gift Tax Return (IRS Form 709). Any gifts that you make in excess of the annual exclusion amount will reduce the basic exclusion amount claimed by your Estate upon your death. For example, assume that you give $1,000,000 to your child. The first $15,000 is exempt due to the annual exclusion amount. The basic exclusion amount in effect in the year of your death will be reduced by $985,000.

What happens if I give more than the basic exclusion amount during my lifetime?

If you give more than the basic exclusion amount during your lifetime, you will owe a Federal Gift Tax on the value of any gifts in excess of the basic exclusion amount.

What is the rate for the Federal Gift Tax?

Any taxable gifts in excess of the basic exclusion amount will be subject to a tax rate of forty percent (40%).

Can you give an example of how this all works?

Assume that Fred is single and has four adult children (Amy, Chris, Jess, and Pat). In 2018, he gives $1,000,000 to his children. In 2019, he gives another $1,000,000 to his children. In 2020, he gives another $1,000,000 to his children. The annual exclusion amount each of those years is $15,000. Because he is giving to four people, Fred uses a total of $60,000 of annual exclusions each year. Of the $1,000,000 gifted to his children each year, $940,000 will be considered taxable gifts. Over a period of three years, his total taxable gifts will equal $2,820,000. Because this is less than the basic exclusion amount, Fred will not owe any Federal Gift Tax in any of these years.

However, if Fred dies in 2021, his basic exclusion amount will be reduced from $11,700,000 to $8,880,000 due to the taxable gifts that he made during his lifetime. If the net assets of Fred’s Estate is worth $10,000,000, then $1,120,000 will be subject to the Federal Estate Tax. At a rate of 40%, Fred’s Estate will owe $448,000 of Federal Estate Tax.

Attorney R. Nicholas Nanovic is an Accredited Estate Planner®, serving as chair of Gross McGinley’s Wills, Trusts & Estates team and on the Tax Law team.