The federal estate tax is a tax on your right to transfer property at your death. In a nutshell, any property you own at your death will be subject to federal estate taxation. If you try to reduce your estate by giving your property away during your lifetime, the value of the property you give away will be subject to gift taxation. And if you leave property to your grandchildren, the value of that property will be subject to generation skipping transfer tax.
This is a vast generalization of the transfer taxation system. Federal transfer taxation rules are complex and subject to a series of exceptions, exemptions, exclusions and special rules carved out to provide a certain amount of relief from transfer tax liability. It would be impossible to cover every nuance specific to each topic addressed in these pages. The goal here is to provide the reader with general information in an effort to understand estate planning, its importance and how a comprehensive plan could result in reduced taxes.
Most people will not find use in the credit as their estates just aren't large enough. The amount exempted from tax by the unified credit (the 'applicable exclusion amount' of the credit) was $5,490,000 in 2017 and has been raised to $11,180,000 in 2018 for individuals and $22,400,000.
This credit means that if you passed away in 2018, the first $11,180,000 million of your taxable estate will be exempt from federal estate taxation. You are actually receiving a credit which effectively exempts a total of $11,180,000 million in cumulative taxable transfers made by you (by lifetime gifts as well as transfers at your death).
The highest marginal rate of estate, gift and generation skipping tax for 2018 remains at 40 percent.
Simply put, if you die in 2018, after calculating deductions and credits, the first $11,180,000 in assets you own will not be subject to estate tax. If the amount of your taxable estate is above $11,180,000, your estate will be subject to federal taxation on amounts 1 million over the credit exclusion at the marginal rate of 40%.
If you are married, that exclusion amount is doubled and assuming the surviving spouse hung on to the whole amount excluded from taxation, the surviving spouse could pass it to her beneficiaries at her death without those assets being subject to the estate tax if certain estate planning techniques where utilized, or the survivor made a 'portability' election when the first spouse died. However, this would have required the filing of a federal estate tax return even if no tax were due.
Gift Tax and Federal Estate Tax
You can give away a cumulative total of up to $11,180,000 to whomever you desire during your life without owing any federal gift tax. The gift tax is imposed on lifetime transfers of property for less than adequate and full consideration in money or money's worth. A transfer is subject to gift tax once it becomes a completed gift. To the extent you use this exemption amount against a gift tax liability, it reduces (or eliminates) the credit available for use against the federal estate tax at your death as the total amount of taxable gifts given during your life would be cumulative and subtracted from your regular unified credit available in the year of death.
The gift tax is said to be determined on a tax-exclusive basis. In contrast, at your death, your gross estate includes the money that will be used to pay the estate tax (a tax-inclusive calculation). If you made substantial lifetime gifts, you may enjoy a significantly lower tax on the gifts than ultimate estate tax because the money used to pay the gift tax is never included in the tax base used to calculate the amount of the gift (you must survive the gift for three years).
There is an annual gift tax statutory exclusion in the amount of $15,000 for 2018 that allows an individual to make gifts up to this amount to multiple donees each year free of tax . Additionally, most gifts or transfers between spouses pass free from gift and estate taxation (see Marital Deduction and Utilizing the Unified Credit). Also, there are multiple tax benefits involved with gifts or transfers to qualified charities.
The Annual Exclusion (0 tax) amount has been raised to $15,000. Parents who take advantage of gift-splitting can increase this amount to $30,000. For those with foreign spouses, the foreign earned income exclusion amount was increased to $104,100 from $102,100.
Generation Skipping Tax (GST)
GST applies when transfers are made directly to members of younger generations (effectively "skipping" a generation), when distributions are made from trusts to members of younger generations and when an interest in property of an older generation terminates in favor of a younger generation. The most common instance involving GST is where a grandparent leaves an inheritance directly to a grandchild and the child's parent is still living. However, the parties do not need to be related for there to exist a GST liability. If the beneficiary of the gift or estate is 37.5 years younger than the donor (or deceased) the transfer may be subject to GST. The exemption amount.
Gross Estate vs. Probate Estate
Your gross estate, before modifications, is the value of all your property interests at the time of death. At your death, your gross estate that will be calculated for estate taxes will consist of everything you own, where ever located, on other property transferred during life over which you retained some interest or control, and, under certain circumstances, property given away within three years of your death.
Your taxable estate is very different from your probate estate. For example, while property owned as joint tenants, or property for which you have designated a beneficiary (life insurance, retirement plans) are not included in your estate for probate purposes, they will, nevertheless, be included in your estate for the calculation of federal estate tax.
Even if your total estate will avoid the payment of estate taxes, if you don't have an estate plan, your estate will still be subject to probate costs and fees if your assets are more than $150,000 (probate threshold amount in the State of California).