Estate and Gift Taxes

AuthorJeffrey Lehman, Shirelle Phelps

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A combined federal tax on transfers by gift or death.

When property interests are given away during life or at death, taxes are imposed on the transfer. These taxes, known as estate and gift taxes, apply to the total transfers that an individual may make over a lifetime.

Estate and gift tax law is primarily statutory. Although the TREASURY DEPARTMENT issues regulations governing the interpretation of the revenue laws, and although state and federal courts contribute their interpretations of statutory law, the foundation of the transfer taxes rests in chapters 11 and 12 of the INTERNAL REVENUE CODE. To understand the complex statutory framework requires a basic understanding of the concepts underlying the estate and gift tax system. The transfer tax laws apply to all gratuitous shifts in property interests. But although administered similarly, the estate tax and gift tax have somewhat different goals. The gift tax reaches the gratuitous ABANDONMENT of ownership or control in favor of another person during life, whereas the estate tax extends to transfers that take place at death, or before death, as substitutes for dispositions at death. Both taxes are intended to limit the concentration of familial or dynastic wealth.

Estate and gift taxes became a source of political debate in the late 1990s, as many members of Congress pressed for an end to these taxes. They argued that such "death taxes" were unfair and forced small businesses and family farmers to sell off their assets to pay the estate taxes. Opponents of repeal noted that even though the potential tax rate was quite high, at 55 percent, most individuals never paid any

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estate or gift tax. Under the tax system that had been in place since 1986, every person could transfer a combined $600,000 worth of property during life and at death without paying tax. This tax-free allowance corresponded to $192,800 worth of federal tax savings and is known as the "unified credit against estate tax." This unified credit was sufficient to satisfy taxes on transfers by all but the richest five percent of U.S. citizens. Defenders of estate and gift taxes maintained that these taxes were guided by an important government and social policy: the prevention of large concentrations of dynastic wealth. Moreover, they pointed out that estate tax collections typically constitute less than two percent of total INTERNAL REVENUE SERVICE collections.

The debate on this issue culminated in the Economic Growth and Tax Relief Reconciliation Act of 2001. The top estate tax rate was reduced from 55 percent to 50 percent in 2002 (together with the repeal of the 5 percent surtax on estates over $10 million), 49 percent in 2003, 48 percent in 2004, 47 percent in 2005, 46 percent in 2006, and to 45 percent in years 2007 through 2009. The credit-level exemption was raised from $675,000 to $1 million in 2002, $1.5 million in 2004, $2 million in 2006, and $3.5 million in 2009. Most importantly, the estate tax was to be repealed in 2010. However, the law contains a "sunset" provision. If Congress does not extend the law beyond 2010, the new law will end on December 31, 2010, and the previous estate law will be in effect again. Since the political landscape undoubtedly will have changed, it is impossible to predict what will happen to the estate tax.

The gift tax was not repealed, but it was modified. The new law increases the total gift tax exemption from $675,000 in 2001 to $1,000,000 in 2002 and thereafter. After 2009, the gift tax is retained at the top INCOME TAX rate for the applicable year, which is currently 35 percent. The retention of the gift tax is meant to discourage transfers to lower income beneficiaries to minimize capital gains taxes.

With few exceptions, the individual making the transfer is responsible for any transfer tax owed (whereas, in contrast, the individual receiving income is responsible for any income tax owed). Thus, the executor of an estate, as the estate's representative, is responsible for paying any estate tax due, and the donor of a gift is responsible for paying any gift tax due.


The Internal Revenue Code defines a gift as a "transfer ? in trust or otherwise, whether the gift is direct or indirect, and whether the property is real or personal, tangible or intangible." Generally, a gift is any completed transfer of an interest in property to the extent that the donor has not received something of value in return, with the exception of a transfer that results from an ordinary business transaction or the discharge of legal obligations, such as the obligation to support minor children. This definition of gifts does not require the intent to make a gift. An individual may make gifts of both present interests (such as life estates) and future interests (such as remainders) in property (26 U.S.C.A. § 2503(b)).

From a tax standpoint, gifts have two principal advantages over transfers at death. First, gifts allow a donor to transfer property while its value is low, allowing future appreciation in property value to pass to others free of additional gift or estate tax. Second, provided that the gift is of a present interest in property, a donor may transfer up to $11,000 exempt from tax to each donee every calendar year, which allows the donor to reduce the size of the estate remaining at death without any transfer tax consequences.

To constitute a gift, a transfer must satisfy two basic requirements: It must lack consideration, in whole or in part (that is, the recipient must give up nothing in return); and the donor must relinquish all control over the transferred interest. To constitute a tax-exempt gift, a transfer also must constitute a present interest in property. (A present interest is something that a person owns at the present time, whereas a future interest is something that a person will come to own in the future, such as the proceeds of a trust.)

Lack of Consideration A transfer is not a gift if the transferor receives consideration, or something of value, in return for it. For example, if A sells B a used car worth $5,000 and receives $5,000 in exchange, the transfer is not a gift because it is supported by "adequate and full consideration" (26 U.S.C.A. § 2512(b)). But if A sells B the same car for only $2,000, the transfer constitutes a gift of $3,000 because A exchanges $3,000 worth of car for nothing. Finally, if A gives B the car without receiving anything in return, the transfer constitutes a gift of $5,000. Although consideration may be whole or partial, not all transfers for partial or insufficient

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consideration result in gifts. An arm's-length sale?that is, a sale free of any special relationship between buyer and seller?will not be considered a gift where no intent to make a gift exists, even if the consideration is not adequate. This limit on the definition of gifts excludes bad business deals and forced sales from gift tax treatment.

The Completeness Requirement A transfer constitutes a gift for tax purposes only if the donor has parted...

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