Wealth Transfer: Estate Tax and Gift Tax

With individual and entity taxation covered, the final piece of the tax picture is wealth transfer. When assets move from one person to another through gifts or inheritance, a separate set of tax rules applies. These rules shape how advisers recommend clients structure their estate plans.

Gift Tax

The gift tax applies when a person transfers property to another person without receiving full value in return. However, several exclusions and exemptions mean most gifts are never actually taxed.

Annual Exclusion:

• $18,000 per recipient per year (2024, indexed for inflation)
• A donor can give $18,000 to as many different recipients as they want, with no gift tax consequences
• Gift splitting: A married couple can combine their exclusions, giving up to $36,000 per recipient per year
• Gifts within the annual exclusion do not require a gift tax return

Lifetime Exemption:

• $13.61 million per individual (2024), unified with the estate tax exemption
• Gifts that exceed the annual exclusion reduce the lifetime exemption dollar-for-dollar
• The lifetime exemption is shared between gift tax and estate tax (a unified system)

Unlimited Deductions:

• Unlimited marital deduction: A U.S. citizen can give unlimited gifts to their U.S. citizen spouse with no gift tax
• Unlimited charitable deduction: Gifts to qualified charities are fully deductible from the gift tax

Exam Tip: Gotchas

• The annual exclusion is per recipient, not per donor. A donor can give $18,000 each to 100 different people ($1.8 million total) without using any of the lifetime exemption.
• Gifts above the annual exclusion do not trigger immediate tax. They simply reduce the donor's remaining lifetime exemption. Actual gift tax is owed only after the entire $13.61 million lifetime exemption is exhausted.

Estate Tax

The estate tax applies to the transfer of a deceased person's assets to their heirs. It is calculated on the total value of the estate at death, minus allowable deductions.

Key provisions:

• Unified exemption: $13.61 million per individual (2024), the same pool shared with the lifetime gift tax exemption
• Estates valued below the exemption owe no federal estate tax
• The top estate tax rate is 40% on amounts exceeding the exemption

Portability:

• If the first spouse to die does not use their full exemption, the surviving spouse can claim the deceased spouse's unused exemption (DSUE)
• This effectively gives a married couple up to $27.22 million in combined exemptions (2024)
• Portability must be elected on a timely filed estate tax return (Form 706), even if no tax is owed

Unlimited Marital Deduction:

• Assets passing to a surviving U.S. citizen spouse are exempt from estate tax regardless of amount
• This allows deferral of estate tax until the second spouse's death

Exam Tip: Gotchas

• Portability is not automatic. The surviving spouse must file Form 706 (estate tax return) to claim the deceased spouse's unused exemption, even if no estate tax is owed.
• The marital deduction requires U.S. citizenship. A surviving spouse who is not a U.S. citizen does not qualify for the unlimited marital deduction.

Step-Up in Basis

The step-up in basis at death is a major tax planning concept and one of the most frequently tested estate tax topics.

How it works:

• When a person dies, inherited assets receive a new basis equal to their fair market value (FMV) at the date of death
• This replaces the decedent's original cost basis entirely
• All unrealized capital gains are eliminated

Example:

In this example, $450,000 of unrealized capital gains disappears entirely because of the step-up.

Comparison: Gift basis vs. inherited basis:

This difference drives a common planning strategy: hold highly appreciated assets until death rather than gifting them during life. The step-up eliminates the capital gains tax that would have been owed.

Exam Tip: Gotchas

• Gifts use carryover basis; inheritance uses stepped-up basis. Gifts carry the donor's original basis, while inherited assets reset to fair market value (FMV) at death. This distinction is frequently tested.
• The step-up can also be a "step-down." If an asset has declined in value, the heir's basis is the lower FMV at death, and the unrealized loss is permanently lost.
• The step-up applies to all inherited assets, not just stocks. Real estate, collectibles, and business interests all receive a stepped-up basis.

The Unified Transfer Tax System

The gift tax and estate tax work together as a unified system with a single lifetime exemption pool.

Think of it this way: The lifetime exemption is like a single bank account that covers both gifts during life and transfers at death. Every dollar you "spend" on lifetime gifts reduces the balance available to shelter your estate.

How the unified system works:

1. During life: Taxable gifts (above the annual exclusion) reduce the $13.61 million lifetime exemption
2. At death: The remaining exemption shelters estate assets from tax
3. Total combined gifts + estate cannot exceed the exemption without triggering tax

Example:

Exam Tip: Gotchas

• The lifetime gift exemption and estate tax exemption are the same pool. Using $3 million during life leaves only $10.61 million at death.
• The exemption amount is scheduled to decrease significantly after 2025 under current law (sunset of the Tax Cuts and Jobs Act provisions). The IRS has confirmed a "no clawback" rule: gifts made while the higher exemption was in effect will not be retroactively taxed.