Transfer taxes are those taxes imposed when property is transferred from one party to another. The estate tax and the gift tax are wealth-transfer taxes that combine to create the unified transfer-tax system. Gift taxes apply if a person transfers property while alive; estate taxes apply when a property is transferred after death. Gift and estate taxes are calculated on a property’s fair market value on the date of the gift or on the date of death (or six months later if eligible to so elect). These taxes can also be considered an “excise tax” on the privilege of transferring property to another. The vast majority of all property transfers are exempt from these property transfer taxes due to the annual gift-tax exclusion ($11,000/person/year) and various deductions and credits. Transfer taxes can affect small business owners when transferring ownership to their children. Critics of estate and gift taxes often portray these measures as forcing the break-up of the family farm or business.
The current system of estate and gift-transfer taxes will be in place until December 31, 2009. The Economic Growth and Tax Relief Reconciliation Act of 2001 repealed the estate tax, effective for deaths occurring after December 31, 2009. Gift taxes were not repealed, however, and are slated to continue into the future unabated. The tax rate for taxable gifts after December 31, 2009, will be the highest individual income-tax rate.
There is a certain amount of uncertainty about planning for estate taxes, because the Economic Growth and Tax Relief Reconciliation Act of 2001 also contains a “sunset clause” that results in all of the act’s provisions being repealed as of December 31, 2010. As a result, the estate, gift, and generation-skipping transfer provisions in effect in 2001 will become law once again on January 1, 2011, if Congress takes no intervening action.
For the period up to December 31, 2009, the gift tax and the estate tax are calculated on a cumulative basis. The transfer-tax rates range from 18 to 55 percent, depending on the value of the decedent’s estate and the sum of the prior taxable gifts. Generally estate tax is owed to the federal government if the decedent’s taxable estate exceeds a specified exemption equivalent amount at the date of death. The exemption equivalent amount is $1 million for 2002 and 2003, $1.5 million for 2004 and 2005, $2.0 million for 2006–08, and $3.5 million for 2009. The gift-tax exclusion is constant at $1 million for all years from 2002 into the future. These generous exclusion amounts result in only a fraction of all estates or gifts being subjected to tax at transfer.
Until 2010, the same tax rates that apply to the estate tax apply to the gift tax. These are considered companion taxes because gifts made during a person’s lifetime reduce the value of the estate and thus the amount of the estate tax that will be owed after the person dies. Using the same tax rates for both recognizes that gifts and estates serve the same purpose: the transfer of wealth. By applying the same rate structure, the government is leveling the playing field between lifetime and post-death transfers. Whether a person chooses to transfer wealth during his/her lifetime or after death, the tax on that transfer will be the same. If an individual uses the $1 million exclusion for lifetime gifts, the amount of the estate that can pass estate-tax-free will be reduced by that amount. In essence, with each taxable gift, all prior taxable gifts are added back to the tax calculation, and the tax is then reduced by the tax calculated on the prior taxable gifts. The effect of this calculation is that successive gifts (and the eventual estate) are forced into higher marginal transfer-tax rates.
The recipient of gifted property takes a tax basis in the property equal to the donor’s carryover basis plus a portion of the gift tax paid. If the full market value (FMV) of the gift is less than the donor’s basis, the recipient will take the lower amount (FMV) as basis. The recipient of property that passes at death generally takes a basis in the property equal to the fair market value on the date of the decedent’s death (for decedents dying before December 31, 2009).
There exists a gift-tax exclusion of $11,000 per donee per year for gifts of a present interest (one whose recipient is allowed to enjoy the gift currently). If a donor is married, the donor’s spouse could agree to “split” the gift, resulting in a total possible transfer of $22,000 (2 × $11,000) tax-free per year. A donor may claim exclusions for transfers to an unlimited number of donees.
Another federal transfer tax, the generation-skipping transfer tax, originated in the realization that when property is bequeathed (transferred at death) from grandparents directly to grandchildren, a transfer is skipped and less total tax is collected. The generation-skipping tax’s purpose is to ensure that some form of transfer taxation is imposed one time per generation. The generation-skipping tax is imposed at the highest estate-tax rate. The tax applies to direct-skip gifts and bequests and to taxable terminations of and taxable distributions from generationskipping transfers. However, every grantor is entitled to a $1,060,000 exemption from the generation-skipping transfer tax (2002–03), $1.5 million (2004–05), $2 million (2006–08), and $3.5 million (2009). The generationskipping tax is also repealed as of December 31, 2009.
After the estate tax is repealed in 2010, there will be a limited amount of basis “step up” available. Recall that for deaths occurring before December 31, 2009, all the assets passing through the estate receive a stepped-up (or steppeddown) basis to fair market value. After December 31, 2009, there will be a total amount of $1.3 million that an estate can increase the basis of assets transferred (basis increase can not increase basis higher than the fair market value of the assets). An estate can increase the basis of assets transferred to a surviving spouse by an additional $3 million. The total step-up in basis for a surviving spouse can be $4.3 million of increase, given an estate with sufficient FMV of assets.
Transfers to an individual’s spouse, either by gift or estate, are exempt from taxation. This “unlimited marital deduction” allows all spousal transfers to be free from tax. In addition, a marital deduction can be taken for property where the recipient spouse is not entitled to designate which parties eventually receive the assets. This “qualified terminable interest property” (QTIP) gives the surviving spouse all the income from the property, payable at least annually. In addition, no person has the power to appoint any portion of the property to anyone other than the surviving spouse unless the power cannot be exercised during the spouse’s lifetime.
Linda Bradley