Ch7. Estate and Gift Taxes — Transferring Wealth Tax-Efficiently

The Unified Gift and Estate Tax System

The U.S. federal government imposes a single unified tax on lifetime gifts and transfers at death. Understanding both together is essential for planning.

Federal Estate and Gift Tax Rate: up to 40% (on amounts above the exemption)

2024 Lifetime Exemption (unified credit):
  $13.61 million per individual
  $27.22 million per married couple (with portability)

For most people, the federal estate tax is not a concern. But the strategies used by large estates are also useful at smaller scale for state estate taxes, which can kick in at much lower thresholds (e.g., Massachusetts: $2 million).

Federal Gift Tax — Annual Exclusion

You can give any number of people up to the annual exclusion amount each year, free of gift tax and without touching your lifetime exemption.

2024 Annual Exclusion:
  $18,000 per recipient
  $36,000 per couple (gift-splitting)

Example:
  You have 3 children and 4 grandchildren (7 people)
  You and your spouse each give $18,000 to each:
  2 × $18,000 × 7 = $252,000 per year transferred tax-free
  Lifetime exemption: untouched

Special Exclusions (Not Subject to Gift Tax)

Direct payments to educational institutions (tuition only, not room/board)
Direct payments to medical providers
→ These are unlimited and do not count against the annual exclusion

The Lifetime Exemption and Portability

Gifts exceeding the annual exclusion file Form 709 (Gift Tax Return)
→ No tax is due until cumulative lifetime gifts exceed the exemption

Example:
  Annual exclusion:   $18,000
  Gift to child:      $100,000
  Taxable gift:       $82,000 (reduces lifetime exemption by $82,000)
  Tax due now:        $0 (exemption still covers it)

Portability (for Married Couples)

If the first spouse to die does not use their full exemption,
the surviving spouse can inherit ("port") the unused amount.

Requirement: timely file Form 706 (Estate Tax Return) even if no tax is owed.

Example:
  Spouse A dies 2024 with $3.61 million estate
  Unused exemption: $13.61M − $3.61M = $10.00 million
  Surviving spouse's total exemption: $13.61M + $10.00M = $23.61 million

Stepped-Up Basis — A Key Estate Planning Tool

Assets inherited at death receive a new cost basis equal to the fair market value at the date of death. This erases all unrealized capital gains.

Example:
  Grandparent bought stock for $10,000 in 1990
  Value at death: $200,000
  
  If sold before death:  capital gain of $190,000 (taxable)
  If inherited:          basis resets to $200,000 → zero capital gain if sold immediately
  
Implication: do NOT sell highly appreciated assets to make gifts;
             pass them at death to benefit from the step-up in basis

The 2025–2026 Sunset

The Tax Cuts and Jobs Act (2017) doubled the lifetime exemption. Without Congressional action, it reverts to approximately $7 million per person on January 1, 2026.

Pre-sunset (2024):     $13.61 million per person
Post-sunset (~2026):   ~$7 million per person (inflation-adjusted)

→ Married couples with estates above $14 million should take action before 2026
→ Gifts made now lock in today's higher exemption even after the sunset

Common Estate Planning Tools

Revocable Living Trust

Assets held in trust avoid probate (saves time and cost)
→ Does NOT reduce estate taxes (assets still included in estate)
→ Provides privacy and continuity of management

Irrevocable Trust

Assets transferred to an irrevocable trust are generally outside your estate
→ Examples: SLAT (Spousal Lifetime Access Trust), GRAT, IDGT
→ Removes future appreciation from the estate
→ Must give up control — cannot take back assets

Annual Gifting Strategy

Systematic annual gifts remove assets (and future appreciation) from the estate

Example:
  Give $18,000/year to each of 5 grandchildren for 20 years
  Total removed: $18,000 × 5 × 20 = $1.8 million
  Plus all investment growth on those funds — also out of the estate

529 College Savings Plans — 5-Year Election

You can front-load 5 years of annual exclusion gifts into a 529:
  $90,000 per beneficiary (single) or $180,000 (couple)
  No additional gifts to the same beneficiary for 5 years

State Estate Taxes

Twelve states (and D.C.) impose their own estate taxes, some with exemptions far below the federal level.

Examples:
  Oregon: $1 million exemption (top rate 16%)
  Massachusetts: $2 million exemption
  Washington state: $2.193 million exemption

→ Even if you owe no federal estate tax, state tax may apply
→ Consider domicile planning if you live in a high-estate-tax state

Practice Quiz

Q1. You want to give your daughter $80,000 this year. You’re single. How much of this gift reduces your lifetime exemption?

Annual exclusion: $18,000. Taxable gift =$ 80,000 − $18,000 = **$ 62,000** reduces the lifetime exemption (no tax due now — just reported on Form 709).

Q2. Your father bought shares for $20,000 and they're worth$ 500,000 when he dies. You inherit the shares. What is your cost basis, and how much capital gains tax is owed if you sell immediately?

Your basis is stepped up to $500,000**. Selling immediately = **$ 0 capital gain and $0 tax.

Q3. Why might a married couple want to file a Form 706 even if no federal estate tax is owed at the first spouse’s death?

To elect portability of the deceased spouse’s unused exemption (DSUE). Without filing Form 706, the surviving spouse forfeits the unused exemption — potentially exposing a larger combined estate to tax later.