Federal gift and estate taxes are both treated under the same section of the U.S. tax code. The Unified Tax Credit is applied to taxes on both, making it easier to give away your wealth while you are alive. The credit not used up during your lifetime can then be applied to estate tax.
Annual Gift Tax Exemptions
Each taxpayer has an annual gift tax exemption. In 2009, up to $13,000 in gifts was completely exempted from tax. This means you could give gifts worth up to $13,000 to any number of other people, and those gifts would be exempt from taxes. When giving valuable items, married couples filing jointly may use both individual exemptions in order to exempt up to $26,000; if the gift is to another married couple, that doubles the possible exemption again to $52,000. Beyond this, annual gift tax is applied.
The Unified Tax Credit
The Unified Tax Credit is designed to ease the tax burden on annual gifts as well as estates. If you make a gift valued higher than the annual exemption, the tax credit can be applied to the non-exempt value. For instance, if you give your son a home worth $100,000, the non-exempt portion of the gift would be $87,000. If, however, you and your husband were to jointly give the same house to your son and his wife, you could use four different gift tax exemptions totaling $52,000, and the non-exempt portion would be only $48,000. The Unified Tax Credit, as of 2010, can exempt a total lifetime gift value of up to $1 million. Every dollar of tax credit you use toward eliminating gift tax, however, is subtracted from your lifetime Unified Tax Credit total, which means you can no longer use that portion of tax credit toward estate taxes. For the most recent value of the Unified Tax Credit, see the most recent IRS Publication 950, listed in References.
All non-exempt inherited properties are subject to the estate tax. As of 2010, estates valued up to $3.5 million are exempt. Any value over this are taxed at 35 percent. This exemption is part of the Unified Tax Credit. If you have already used a portion of it to offset gift tax, that portion is subtracted from the $3.5 million. Using the example above, after giving your son his $100,000 home, you and your husband used $48,000 of your lifetime Unified Tax Credit. You and your husband each have up to $3.5 million total exempt, for a total of $7 million. After the gift, you still have a combined $6,952,000 value that can be exempted. The value of your estate over this value is taxed at 35 percent after your death.
Gift and Estate Planning
The estate tax, termed the "death tax" by conservatives, was a hotly contested issue in the last decade. The law on estate tax is in a state of flux and what is true one year may be drastically changed in the next. Many people of wealth have chosen to use living trusts and other financial tools to protect their wealth during their lifetimes and afterward. Because the rules governing estate and gift tax are complicated and easy to misinterpret, it is wise to consult an experienced professional when planning lifetime gifts and inheritance if you think their values may exceed tax-exempt levels.
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