Overview of Federal Estate and Gift Taxes

While virtually every American is familiar with the federal income tax, the U.S. Internal Revenue Code contains another major system of progressive taxation related to individual wealth: the taxation of the passage of wealth through gratuitous transfers of property by individuals. This overall area of taxation is embodied in three separate, but interrelated “taxes”: the estate tax, the gift tax and the generation-skipping transfer tax. These taxes, which are administered by the U.S. Treasury Department’s Internal Revenue Service, are unfamiliar to most Americans, because they impact only the small portion of the population whose accumulated wealth exceeds certain relatively high threshold levels. For the wealthier segment of the population who are affected, these taxes can be very significant, and their ultimate impact can often be reduced by careful planning.

In General

A gift tax is imposed on certain lifetime transfers, and an estate tax is imposed on certain transfers at death. A generation-skipping transfer tax generally is imposed on transfers, either directly or in trust or similar arrangement, to a “skip person” (i.e., a beneficiary in a generation more than one generation younger than that of the transferor). Transfers subject to the generation-skipping transfer tax include direct skips, taxable terminations, and taxable distributions.

Income tax rules determine the recipient’s tax basis in property acquired from a decedent or by gift. Gifts and bequests generally are excluded from the recipient’s gross income.

 Common Features of the Estate, Gift and Generation-Skipping Transfer Taxes

Unified Credit  – The New 2018 Rules

The new rules double the Federal estate, gift and generation-skipping transfer (“GST”) tax exemption amounts from $5 million to $10 million per individual, with additional inflation adjustments as under prior law. The increased, inflation-adjusted exemption amounts – approximately $11.2 million for an individual, or a combined $22.4 million for a married couple – are effective for estates of decedents dying, and gifts made, after December 31, 2017 (with potential future inflation adjustments for 2019 and subsequent tax years), but are scheduled to expire on December 31, 2025, after which the relevant Federal estate, gift and GST tax exemption amounts would revert to the prior $5 million amounts, plus the relevant inflation adjustments.​

Because the doubling of the estate and gift tax exclusion amount will expire for
decedents dying and gifts made after December 31, 2025, the next several years present an opportunity for wealthy individuals and married couples to make large gifts, including those that leverage the amount of the available exclusion, such as those to grantor retained annuity trusts (GRATs) and irrevocable life insurance trusts (ILIT’s).​

An election is available under which exemption that is not used by a decedent may be used by the decedent’s surviving spouse (so-called “portability”).

Common Tax Rate Table

A common tax-rate table with a top marginal tax rate of 40 percent is used to compute gift tax and estate tax. The 40-percent rate applies to transfers in excess of $1 million (to the extent not exempt). Because the exemption amount currently shields the first $5.43 million in gifts and bequests from tax, transfers in excess of the exemption amount generally are subject to tax at the highest marginal 40-percent rate.

Generation-skipping Transfer Tax Exemption and Rate

The generation-skipping transfer tax is a separate tax that can apply in addition to either the gift tax or the estate tax. The tax rate and exemption amount for generation-skipping transfer tax purposes are set by reference to the estate tax rules. Generation-skipping transfer tax is imposed using a flat rate equal to the highest estate tax rate (40 percent).

Tax is imposed on cumulative generation-skipping transfers in excess of the generation-skipping transfer tax exemption amount in effect for the year of the transfer. The generation-skipping transfer tax exemption for a given year is equal to the estate tax exemption amount in effect for that year (currently $5.43 million).

Transfers Between Spouses – The Marital Deduction

In General

A 100-percent marital deduction is permitted for the value of property transferred between spouses. In addition, transfers of “qualified terminable interest property” also are eligible for the marital deduction. Qualified terminable interest property is property: (1) that passes from the decedent, (2) in which the surviving spouse has a “qualifying income interest for life,” and (3) to which an election under these rules applies. A qualifying income interest for life exists if: (1) the surviving spouse is entitled to all the income from the property (payable annually or at more frequent intervals) or has the right to use the property during the spouse’s life, and (2) no person has the power to appoint any part of the property to any person other than the surviving spouse.

Transfers to Surviving Spouses Who are not U.S. Citizens

A marital deduction generally is denied for property passing to a surviving spouse who is not a citizen of the United States. A marital deduction is permitted, however, for property passing to a “qualified domestic trust” of which the noncitizen surviving spouse is a beneficiary. A qualified domestic trust is a trust that has as its trustee at least one U.S. citizen or U.S. corporation. No corpus may be distributed from a qualified domestic trust unless the U.S. trustee has the right to withhold any estate tax imposed on the distribution.

Tax is imposed on (1) any distribution from a qualified domestic trust before the date of the death of the noncitizen surviving spouse and (2) the value of the property remaining in a qualified domestic trust on the date of death of the noncitizen surviving spouse. The tax is computed as an additional estate tax on the estate of the first spouse to die.

Transfers to Charity

Contributions to charitable organizations may be deducted from the value of a gift or from the value of the assets in an estate for Federal gift or estate tax purposes.