Estate & Gift Tax Law
An estate tax is a federal tax, imposed by the Internal Revenue Service, that applies generally to estates worth at least $1 million. The federal gift tax is a tax that people who receive gifts sometimes have to pay, if the gift is large enough. If you want to save estate tax money then you will have to plan around the gift tax.
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Generally
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When you die all of your property is lumped together and called your "estate." If the total taxable value of your estate exceeds a certain amount of money--as of 2009, $3.5 million; as of 2011, $1 million--then your estate will have to pay the federal estate tax before any distributions are made to your family, friends or charity. To save on estate taxes, people often give away property toward the end of their lives. However, the federal gift tax applies to lifetime gifts.
Function
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The function of the estate tax is to tax your property when you die, but before any distributions are made according to your will. The function of the gift tax is generally to prevent people from trying to avoid the estate tax by giving away property before they pass away. The estate tax is different than, say, a state inheritance tax. An inheritance tax applies to money that a person receives from an estate, while the estate tax applies to the whole estate before any money is distributed from the estate.
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Size
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The federal estate tax rate varies depending on the size of your estate and on the year when your estate is valued. As of 2009, the maximum estate tax is 45 percent if you estate value exceeds $3.5 million. But, as of 2010, the estate tax does not apply at all, and then in 2011, the estate tax comes back at a maximum 55 percent rate and applies to estates worth $1 million or more.
The gift tax is kind of tricky. There are two considerations for the gift tax. First, you must calculate the annual gift, and second, you must calculate the running total of gifts from the same person. For the annual gift tax calculation, you can give up to $12,000 to one person tax-free. For the the running total, your lifetime gifts to a single person cannot exceed $1 million.
Considerations
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So who pays the tax? For the estate tax, the executor of your estate will file a tax return with the IRS and write a check for the estate taxes owed. The money comes out of the value of your estate. As for gift taxes, the person who gives the gift is assessed a tax equal to the applicable estate tax for the year. The person who receives the gift is not taxed at all, because gifts are not considered income.
Examples
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Estate tax example: You die in the year 2009 with a total taxable estate value of $4 million. The estate tax exemption is $3,500,000, which means $500,000 is taxed at the rate of 45 million. Your executor will write a tax check for $225,000 to the IRS.
Gift tax example: In 2009, four years before you think you will die, you give your child $22,000. Your gift exceeds the $12,000 gift tax deduction by $10,000, so you will have have to file a gift tax return with the IRS. However, unless your total lifetime gifts to the child exceed $1 million, you will not have to pay a gift tax.
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