Federal estate and gift taxes can be broken down into three major divisions. These divisions are Gift Tax, Estate Tax, and the Generation Skipping Transfer Tax (GSTT). These taxes normally paid by the person giving the gift or estate and not by the person who receives the cash or property.
The Gift Tax
The Gift Tax was passed as a means of providing the Internal Revenue Service a means of taxing gifts of property or cash that is given away before death. Prior to this tax bill being passed, it was not uncommon for people to give away their assets prior to death in an attempt to avoid taxation on the assets as part of the estate.
Technically, all gifts are taxable. However, most people are never required to include them on a tax return. Usually, the following gifts are not taxable:
1.Gifts that are less than the annual exclusion amount for the calendar year. For 2005, the exclusion amount is $11,000 per individual gifted.
2. Tuition or medical expenses pay for someone else.
3. Spousal gifts.
4. Political party contributions.
5. Charitable contributions.
The estate tax is also known as the death tax. Only a small percent of all estates are subject to paying estate taxes. This is because if the estate goes to a spouse or a charity upon death, there is no tax assessed. And, even if the estate is left to others, generally, it must be valued at $1,500,000 or more if the death occurs in 2005 before the estate is subject to filing an estate tax return.
To determine if the estate is taxable, calculate the gross worth of the estate less allowable deduction. The gross estate includes:
Ã?Â· Life insurance proceeds paid to the estate or heirs;
Ã?Â· The value of specific annuities payable to the estate or heirs;
Ã?Â· The value of specific properties transferred within 3 years prior to death;
Ã?Â· And trusts or other interests in which the deceased held powers.
The allowable deductions include:
Ã?Â· Funeral expenses paid out of the estate;
Ã?Â· Debt owed at the time of death;
Ã?Â· And marital deductions, such as the value of property passed from the estate to the surviving spouse.
Generation Skipping Transfer Tax (GSTT)
The Generation Skipping Transfer Tax is meant to fill a loophole used to reduce estate taxes. It imposes the highest estate tax rate of 47% in 2005 on all family property that would be subject to either the gift or estate tax at least once in each generation. Before this tax, it was possible to avoid a tax on each generation either by:
1.) Transferring property in trust to a child for life, after which the property would pass to the next generation without being subjected to gift or estate taxes; or
2.) Property could be passed directly from grandparent to grandchild, either as an outright gift or as a trust, subjecting it only to a single estate or gift tax. Therefore the parents of the grandchild would avoid taxation. The GSTT now applies to these two situations.
There are exceptions to the GSTT, including:
Most gifts exempt from the gift tax;
2. Trust created before 1985;
3. Transfers, up to a per-person lifetime total of $1,500,000 in 2005, designated by the transferor as exempt from the GSTT.
This tax applies to both family and unrelated individuals who are 37-1/2 or more years younger than the transferor.
The hefty significance of these estate and gift taxes makes it important for anyone with substantial assets to carefully consider estate planning long before health issues or unexpected circumstances force the topic to the forefront. Otherwise, the tax man could end with as much of the estate as your heirs do.