Gratuitous transfers of wealth, whether made during life or death is generally not subject to the federal income tax. Instead, your estate could be subject to federal estate, gift, and or generation-skipping transfer taxes. Basically, your estate will have to pay estate taxes when you die if the net value (assets minus debts) is more than the exempt amount at that time. For 2016, the federal estate tax exemption is $5.45 million; every dollar over the exempt amount is taxed at 40%.
Currently, the federal estate tax exemption at $5.45 million; most Americans do not need the estate tax savings. However, in the future, the exemption may be reduced or hopefully, the value of your net estate may increase substantially before you die. So it is good to know the law.
Currently, an individual can make annual tax-free gifts of up to $14,000 per recipient. If you are married, you and your spouse together can give $28,000 per recipient per year. Also, an individual can also give an unlimited amount for tuition and medical expenses if you make the gifts directly to the educational organization or health care provider i.e. you have to write the check to the institution; you cannot give the money to your child and have them pay the tuition or medical expense. As long as the gift is within these limits, you don't have to report it to the IRS.
What if you want to give more than the limit? You can, it just starts using up your federal unified gift and estate tax exemption ($5.45 million). If your gift exceeds the annual tax-free limit, you'll need to let the IRS know by filing an informational gift tax return (Form 709) for the year in which the gift is made. After you have used up your exemption, you'll have to pay a gift tax on any gifts over $14,000 (or whatever the annual tax-free amount is at that time). Currently, the federal gift tax rate is equal to the federal estate tax rate, which is 40%. (Remember, state taxes may also apply.)
Transfers made by one spouse to the other, during life or at death, are generally sheltered from gift and estate tax by a martial deduction.
Generation-Skipping Transfer (GST) Tax
The GST tax reaches transfers that shift property to beneficiaries two or more generations below the level of the intervening (or "skipped") generation. The GST tax functions as a supplement to the estate and gift tax
Federal Estate Tax
Federal estate tax is imposed on the transaction of a decedent's taxable estate. The taxable estate starts with the gross estate. The gross estate includes property owned at death as well as other types of transfers that are deemed to occur at death i.e. revocable trusts, life insurance proceeds. From here certain deductions are allowed for items such as administrative expenses, claims of creditors, and amounts transferred to your spouse, family, and/or charities. After this, you arrive at the taxable estate. The goal of an estate plan is to prevent your estate from paying estate taxes.
Transfers of Property by Gift
Section 2501 (a) of the Internal Revenue Code (IRC) imposes the gift tax o the transfer of property by gift. The tax is required whether the transfer is in trust or otherwise, direct or indirect, and whether it is real or personal, tangible or intangible. Remember - for gift tax purposes, there is not gift unless there is a transfer of property. This means the transfer is complete when the donor relinquishes dominion or control; retaining not power to revoke the transfer or change the interest of the beneficiaries. In general, the gift is valued at the time the gift becomes complete.
The Charitable Deduction
The estate and gift taxes allow a deduction for transfers made to qualifying charitable organizations. If the organization or purpose for the contribution satisfies the criteria, there is no limit on the amount which can be given.
Income Taxation of Trusts and Estates
Generally, a trust is recognized as a separate taxable entity for federal income tax purposes. The most common income tax problems involve determining who should be taxed on the income from property held in trust. Usually, it is one of three: the grantor; the beneficiaries; or the trust itself.
This is an overview of some tax issues people face and how an estate planning attorney can help protect you, your family, and your wealth.