A: Estate and gift taxes are used to tax large transfers of wealth between individuals. Gift taxes are imposed on transfers made during an individual's lifetime, and estate taxes are imposed on transfers made at the time of death. Although gift taxes and estate taxes are paid separately, they are a unified tax in the sense that a single graduated rate schedule applies to the cumulative total of taxable transfers made through gifts and estates. The accompanying table shows this rate schedule. The 2001 tax cut legislation enacted by Congress and President Bush gradually phases out the estate tax over ten years but revives it after sunsetting at the end of 2010. Since the law does not treat the gift tax entirely the same (the gift tax is never fully repealed, for example) the two taxes are no longer fully unified. The maximum tax rates decrease gradually from 2001 through 2010, as shown in the table below.
Although the taxation of gifts and estates may seem complicated at first glance, the calculation of estate and gift taxes is actually quite similar to the calculation of personal income taxes. As with the income tax, there are exemptions and credits that are applied before the progressive rate schedule is applied. Estate taxes are different in one important way, however: they are calculated over a lifetime, not year by year. For income tax purposes, that is, taxable income for 2006 is the total taxable income earned from January 1 to December 31 of 2006. In other words, it doesn't matter how much you earned in 2004 or 2005 -- all that counts is how much you earned in 2006. For estate and gift tax purposes, on the other hand, it does matter how much a taxpayer has given away in the past. The gift tax rate for 2006 depends on the total amount of taxable gifts a taxpayer has given since 1976 (when the estate and gift taxes were unified).
Annual Exemptions: Each taxpayer is allowed to give $12,000 ($24,000 for married joint filers) in gifts to any single individual in the course of a year tax-free in 2006. This is a per-recipient annual exemption, so (for example) a taxpayer wishing to give away $60,000 to her five grandchildren could do so tax-free (if the gifts were split evenly) in 2006. This means that the only way gifts can be taxed is if a single taxpayer gives more than $12,000 ($24,000 for married joint filers) to another individual.
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* Since the excemption for the estate tax or the gift tax are above these amounts these rates are not generally applicable for most purposes. †2011 numbers assume no further legislation to permanently repeal or reduce the estate or gift taxes. |
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Lifetime Credits (Lifetime Exemptions): Most gifts and estate above the
annual exemption are not subject to tax. This is because each taxpayer is allowed
a
lifetime credit
against taxable gifts and estate. The law Congress and President Bush passed
in 2001 created different credits for the estate tax and the gift tax, so that
in that sense the two taxes are not fully unified any more. In
2006,
the
estate tax credit
amount
is $780,800. Under the rate schedule shown in the table, this credit is equivalent
to a $2,000,000 exemption from the estate tax. (To see why this is true, click
here.) We will call this effective exemption amount the lifetime exemption for
the estate tax (to distinguish from the annual exemption, which is $12,000 in
2006).
In 2006, the lifetime credit for the gift tax is $345,800, which is equivalent to a $1,000,000 lifetime exemption from the gift tax. This means that even if a taxpayer gives more than $12,000 to a single recipient in a given year, the gift amount above $12,000 will not be subject to tax unless this taxpayer has already given a total of $1,000,000 in taxable gifts since 1976.
The 2001 law set the lifetime exemption at $1,000,000 for gifts and it gradually increases the lifetime exemption for estates until the estate tax is fully repealed in 2010.
Other Exemptions: There are some cases in which one can give more than $12,000 worth of gifts without facing the gift and estate tax. These include:
Calculating the Tax: Any gifts or estate value left over when all exemptions and credits are taken into account is taxable according to the above table. In 2006, the tax rate ranges from 18 percent on the first $10,000 of taxable gifts and estate to 46 percent on taxable gifts and estate over $3 million. However, since the $780,800 estate tax credit has the effect of exempting the first $2,000,000 of an estate in 2006, the lowest estate tax rate that is applied this year is the 45% rate. Since the $345,800 gift tax credit has the effect of exempting the first $1,000,000 in gifts in 2006, the lowest gift tax applied this year is 39%. (In addition, if the law is allowed to sunset at the end of 2010, a 5 percent surtax will be imposed afterwards on taxable transfers between $10 million and $17,184,000.) Taxable estate value includes the value of all property owned at the time of death plus any gifts made in the three years prior to death. However, this value is reduced by the value of debts, funeral expenses, and costs of administering and settling the estate. Finally, of course, any portion of a decedent's estate that is given to a spouse or to charity is not taxed.
Last Updated 9/27/2006
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