If you want to give a large amount of money to someone, there’s a good chance it will result in a tax burden. This is true whether you decide to transfer the money while you’re alive or after your death as part of your estate. However, estate tax and gift tax differ in key ways, and understanding those differences can help you develop a tax-savvy estate plan.
What Is an Estate Tax?
Estate taxes are one of two so-called death taxes. Inheritance taxes are the other type of death tax.
An estate tax is a tax that’s levied on an estate. The estate needs to pay the estate tax, if one is due, before the heirs can receive their inheritance. Not all estates are subject to estate taxes, but ones that reach a certain threshold are. The federal estate tax applies to estates worth at least $13,610,000 in 2024; the minimum threshold is adjusted each year. Some states also have estate taxes, and the thresholds can be much lower, meaning more estates are subject to taxes. In Oregon, estates are taxed if they are worth at least $1 million.
Inheritance taxes are similar to estate taxes, but they are paid by the heir. There is no federal inheritance tax, but some states have an inheritance tax.
What does an example scenario look like? When Jennie dies, she leaves behind an estate that includes her house, her retirement accounts, and some cash savings. It is worth $2.5 million. The estate is not subject to any federal estate taxes because it does not meet the minimum threshold, but because Jennie lived in Oregon, the estate is subject to Oregon’s estate tax. This is paid before the assets are distributed to Jennie’s heirs.
What Is a Gift Tax?
A gift tax is a tax on property that is transferred to another individual as a gift, whether it’s cash or another type of asset.
As you might expect, something can be considered a gift if the sender receives nothing in return. However, according to the IRS, something can also be considered a gift if the sender receives less than the full value, even if the sender did not intend it to be a gift. For example, if you sell a car at less than its full value, it may be considered a gift and subject to the gift tax. The gift tax is typically paid by the person who makes the gift, not the person who receives it.
Gifts are exempt from the gift tax if they fall below an annual threshold, which adjusts every year. For 2024, the annual gift tax threshold is $18,000. It’s important to note that the gift tax annual exclusion applies to each individual. A married couple can therefore gift up to $36,000 in 2024 before the gift tax applies as long as each spouse only gifts up to $18,000. Gifts to spouses, political organizations, or to cover tuition or medical expenses can also be exempt from gift taxes.
Most people do not need to worry about a state-level gift tax. According to the American Bar Association, Connecticut is the only state with a gift tax.
What does an example scenario look like? George owns a lakefront vacation home that he doesn’t use much, and he wants his adult nephew to have it. The house has a fair market value of $2.5 million, but he sells it to his nephew for $100,000. Because George sold it for less than the full value, it is considered a gift, and gift taxes are assessed.
Deferring the Gift Tax
The IRS says the gift tax return is due on April 15th following the year the gift is made. You can file your gift tax using Form 709.
However, you do not need to pay the gift tax at this time. Instead, you can file the form and defer payment until your death, at which time the total value of lifetime taxable gifts is added to the total value of the estate to determine what estate taxes are owed.
Crafting a Tax-Savvy Estate Strategy
If you have a large estate that you want to share with your heirs, leaving everything in a will may not be the most tax-savvy strategy due to federal and state estate taxes. Instead, it may make more sense to make gifts throughout your lifetime. However, when leveraging this strategy, it’s important to be mindful of gift tax rules. This is a complicated area of estate and tax law, and an attorney who specializes in these matters can provide guidance. Talk to a lawyer.