We have a unified federal estate and gift tax. When applied to gifts which people make during their lifetime it is called gift tax. When applied to property which people leave at their death it is called estate tax.
The tax applies at graduated rates up to a top rate of 40 percent on an individual’s cumulative taxable transfers during life and at death in excess of $1,000,000 in value.
The individual making the gift, called the “donor,” is liable for gift tax. The individual who receives a gift is called the “donee.” The decedent’s estate or personal representative is liable for estate tax.
The federal estate and gift tax exclusion amount is available to shelter gifts from federal gift tax and, to the extent is not used against taxable gifts, may be used to shelter the decedent’s gross estate from federal estate tax. The Tax Cuts and Jobs Act of 2017 raised the federal estate and gift tax exclusion amount from $5,000,000 to $10,000,000, but only for gifts made or decedents dying after December 31, 2017 and before January 1, 2026.
The federal estate and gift tax exclusion amount is indexed annually for inflation. Currently, it is $11,580,000. A well-planned estate of a married couple can pass twice that amount, $23,160,000, to their children, grandchildren or friends free of federal estate and gift tax. The idea is that people should be able to pass a moderately-sized estate free of federal estate tax.
Without legislation the federal estate and gift tax exclusion amount will drop in half on January 1, 2026. Some advisors are recommending that individuals give away their estate now, to avail of the higher exclusion amount while it still exists. For most people this is bad advice.
Property gifted by a donor within three years of his death is includable in his gross estate for federal estate tax purposes. What you would not want to do is gift property and have it come back into your gross estate after December 31, 2025, when the federal estate and gift tax exclusion amount is half what it is now. For the strategy to work gifts should be made by December 31, 2022.
Property received from a decedent, by bequest or inheritance, is received at an income tax basis equal to the property’s fair market value at the date of the decedent’s death. Akin to the cost of property, basis is matched against the sale proceeds in determining realized gain or loss on sale of the property. The idea is that property which is received from a decedent, and which has already been subjected to federal estate tax, ought not also be subjected to income tax.
But property gifted by a donor during his lifetime will not have a step-up in basis to fair market value at the donor’s death. Instead the donee receives the gifted property at the donor’s carryover basis. This is a huge disadvantage to lifetime gifting of appreciated property.
There have been calls to eliminate the step-up in basis of property to fair market value at the death of the property’s owner. This would amount to a tax increase. Tax increases are politically unpopular, and unlikely.
Most importantly, people should not gift property which they may need for their care during their lifetime, regardless of tax consequences at their death. They worked their all their life to build their estate. Their estate should be used first and foremost for their care and comfort throughout their life. Whatever remains of their estate at their death can benefit their children, grandchildren, or beneficiaries. When I represent such an individual, I represent that individual, and not his children, grandchildren, or anyone else who may be interested in his estate.
So, unless you are able to gift up to $5,790,000 worth of property without affecting your financial security in your old age, or you are a married couple able to gift up to $11,580,000 worth of property without affecting the financial security of both spouses in your old age, you should not consider gifting property to avail of the higher federal estate and gift tax exclusion amount.
For most people, gifting property in anticipation of reduction of the federal estate and gift tax exclusion amount is not a good idea.
Stephen J. Dunn is a tax attorney in Troy, Michigan. He is the author of the treatise Foreign Accounts Compliance (Thomson Reuters 2017) and Foreign Accounts Compliance Blog. He is also an adjunct professor at Michigan State University College of Law.
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