Ch7. Estate Tax & Gift Tax — Fundamentals of Wealth Transfer

What Are Estate and Gift Taxes?

Estate tax is a federal tax on the transfer of wealth at death — the estate (all assets owned by the decedent) is taxed before assets pass to heirs. Gift tax is a federal tax on gratuitous transfers of property during life — the donor generally pays.

Estate: Death → property transfers → estate pays estate tax (Form 706)
Gift: Lifetime → gratuitous transfer → donor pays gift tax (Form 709)

Both taxes are governed by the Internal Revenue Code (IRC §§2001–2801) and are federal direct taxes. Note that the estate and gift taxes are unified — they share the same rate schedule and lifetime exemption.

Federal Estate Tax Framework

What Is Included in the Gross Estate?

The gross estate includes essentially everything the decedent owned or had control over at death.

Real property (land and buildings) — at fair market value
Financial assets (checking/savings accounts, stocks, bonds, mutual funds)
Life insurance death benefits (if decedent owned the policy)
Retirement account balances (IRAs, 401(k)s, pensions)
Business interests (partnership, LLC, S-Corp shares)
Taxable gifts made within 3 years of death (§2035 — for certain types)

Estate Tax Calculation Framework

Gross Estate (FMV of all included assets)
− Deductions:
    Marital deduction (unlimited — assets to US citizen spouse)
    Charitable deduction (unlimited — assets to qualifying charities)
    Debts, funeral expenses, estate administration fees
    Mortgages and other liabilities
= Taxable Estate

+ Adjusted Taxable Gifts (post-1976 taxable gifts not in gross estate)
= Estate Tax Base

× Rate Schedule
= Tentative Tax

− Unified Credit (equals tax on the basic exclusion amount)
= Estate Tax Owed

Estate Tax Exemptions and Rates (2025)

Item	Amount
Basic Exclusion Amount (per person)	$13,990,000
Married couple (with portability)	~$27,980,000
Estate tax rate (above exclusion)	40% flat
Filing deadline	9 months after date of death (6-month extension available)

Portability: A surviving spouse can elect to use the deceased spouse’s unused exclusion amount (DSUE) by filing Form 706 within 5 years of the decedent’s death (post-Rev. Proc. 2022-32 simplified procedure available).

Key planning note: The TCJA-doubled exclusion is currently scheduled to sunset after December 31, 2025, reverting to approximately $7M per person (indexed). Tax legislation may change this. Planning now is critical for estates between$ 7M and $14M.

Federal Gift Tax Framework

Annual Gift Tax Exclusion

The annual exclusion allows tax-free gifts to any number of recipients each year — no gift tax return required if gifts to any single person do not exceed the annual limit.

Year	Annual Exclusion Per Donee
2025	$19,000

Married couples can “split” gifts: a married couple can jointly give $38,000 per recipient in 2025 (Form 709 required to elect gift-splitting).

Unlimited exclusion under §2503(e): Payments made directly to an educational institution for tuition, or directly to a healthcare provider for medical care, are excluded from gift tax with no dollar limit. This is separate from and in addition to the annual exclusion.

Gift Tax Calculation Framework

Taxable Gifts = Total Gifts − Annual Exclusions − §2503(e) exclusions

Taxable Gifts reduce the Lifetime Exemption dollar-for-dollar

When Lifetime Exemption is exhausted:
Gift tax rate = 40% flat on taxable gifts

Gift Tax Rates (2025)

The gift tax uses the same rate schedule as the estate tax: 40% on amounts above the unified credit equivalent.

Estate vs. Gift Tax Comparison

Feature	Estate Tax	Gift Tax
When triggered	At death	During lifetime
Who pays	Estate (before distribution)	Donor
Key deduction	Marital deduction (unlimited)	Annual exclusion ($19,000/donee/year)
Valuation	FMV at date of death	FMV at date of gift
Filing deadline	9 months after death	April 15 of following year
Unified exemption	Shared $13,990,000 (2025)	Same

The Core of Estate Planning: Lifetime Gifting Strategy

Why Gift During Your Lifetime?

Estate tax is calculated on everything you own at death. Systematic lifetime gifting reduces the taxable estate — and removes all future appreciation from the estate as well.

Strategy Example (married couple):
  Two children, four grandchildren (6 donees)
  Annual gifts: $38,000 per donee (gift-split) × 6 = $228,000/year
  Over 20 years: $4,560,000 removed from estate with zero gift tax
  Plus: all appreciation on those assets accrues outside the taxable estate

  10 years of education payments to grandchildren's colleges under §2503(e):
  $30,000/year per grandchild × 4 × 10 years = $1,200,000 excluded (no gift tax)

The 10-Year Lookback Rule (§2035 / §2001)

Gifts made within 3 years of death for certain transfers (life insurance, releases of retained interests) are pulled back into the gross estate. For general gifting: taxable gifts made after 1976 are added to the estate tax base to calculate the estate tax — but the gift tax paid is credited against the estate tax. Planning gifts well in advance of death maximizes effectiveness.

Generation-Skipping Transfers (GST)

Transferring assets directly to grandchildren (skipping a generation) is subject to an additional 40% GST tax on top of any gift or estate tax. However, there is a GST exemption equal to the basic exclusion amount ($13,990,000 in 2025). With proper planning, substantial amounts can be transferred to grandchildren or into dynasty trusts free of GST.

Real Property vs. Cash Gifting

Cash gifts are valued at face value — straightforward and precise.

Real property gifts are valued at fair market value (appraisal required for gifts over $5,000 for personal property;$ 500,000+ for real estate).

When gifting real property is advantageous:
Assessed value (for tax purposes) < fair market value
Example: Property with FMV of $1,000,000 but conservative appraisal of $750,000
  → Gift tax calculated on $750,000 (less gift tax owed)

Warning: IRS scrutinizes below-market transactions between related parties
Inadequate appraisals → "gift by operation of law" on the undervalued amount
All appraisals must be by a "qualified appraiser" under IRC §170(f)(11)

Filing Procedures

Estate Tax (Form 706)

Deadline: 9 months after the date of death (automatic 6-month extension available via Form 4768)
Payment options: lump sum, installment (§6166 for closely held business interests), in-kind payment of certain assets
Filing: Form 706 + supporting schedules (A through R) filed with IRS
Portability election: must be made on a timely filed or late-filed (within 5 years) Form 706

Gift Tax (Form 709)

Deadline: April 15 of the year following the gift (same extension as Form 1040)
When required: any gift to a single recipient exceeding the annual exclusion in a calendar year, or any use of the lifetime exemption, or gift-splitting election
Payment: due by original filing deadline (April 15), even if extension granted for filing

Common Mistakes

Mistake 1: Valuing closely held business interests too conservatively

The IRS can challenge low valuations in family business transfers. Minority interest discounts and lack-of-marketability discounts must be supported by a qualified business appraiser. Deficiencies result in estate or gift tax deficiencies plus penalties.

Mistake 2: Intra-family loans without adequate interest

Loans between family members must charge at least the Applicable Federal Rate (AFR) published monthly by the IRS. Below-AFR loans are treated as part gift, part loan. The deemed interest income must also be reported by the lender.

Mistake 3: Misunderstanding “encumbered gift” (bargain sale / part-gift-part-sale)

Gifting property subject to a mortgage creates a “bargain sale” — the debt assumed by the donee is treated as sale proceeds to the donor. This can trigger capital gains tax on the debt portion, even in what appears to be a pure gift transaction.

Summary

Item	Key Point
Estate tax basic exemption	$13,990,000/person; ~$ 28M for couples with portability (2025)
Gift tax annual exclusion	$19,000 per donee (2025)
§2503(e) exclusion	Unlimited — direct tuition + medical payments
Top rate	40% (both estate and gift tax)
Pre-death gifting strategy	Gift 10+ years before death; maximize annual exclusions; use §2503(e)
Filing deadlines	Estate: 9 months after death; Gift: April 15 of following year

The best wealth preservation is accomplished by planning early. Start annual gifting when children are young, and begin estate planning well before age 60. Waiting until a serious health event creates irreversible tax exposure.

OIYO Editorial