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What Are Estate Taxes, and Will I Have To Pay Them If I Gift Assets Now?

| January 20, 2021

Estate taxes are what is paid to the federal government when someone passes away and assets are transferred to the next generation. The tax is assessed on the total amount of assets above the applicable exemption in the year of the persons passing.

Estate taxes have been a source for funding the federal government since nearly the inception of our country. They can be traced back to 1797 when Congress issued a federal stamp requirement on all wills to pay for the war against France. It was ultimately repealed when the war ended. The tax was on again, off again to help pay for several more wars up until it became permanent with the passing of The Revenue Act of 1916.

This tax on assets transferred to the next generation has been as high as 77% (1941-1976) with exemptions as low as $40,000 per person. For 2021 an individual exemption is much higher at $11.7 million (doubled for married couples). This means an individual can pass on $11.7 million in wealth to the next generation without paying the current 40% estate tax. 

I want to avoid this and gift now; will I be taxed?

Currently the estate tax exemption and gift tax exemption are the same at $11.7 million. So, if an individual gifts a large amount, say $100,000 of assets to another non-spouse person, they will just have to file a gift tax return which in turn will reduce their estate tax exemption by the amount of the gift. No taxes on the gift. However, they would have to reduce their estate tax exemption by the gift amount, so for this individual they would only be able to pass $11.6 million to their heirs before the tax kicks in. Still a sizable amount to pass tax free!

So, you will not be taxed at the time of your gift, but your estate could incur more estate tax when you pass away. However, you can gift $15,000 to any one person ($30,000 if married filing jointly) and NOT file a gift tax return, meaning it does not reduce your estate tax exemption. This is called the annual gift exclusion amount and it adjust for inflation each year. This can be a great strategy for those worried about future estate taxes. Doing this each year, possibly even to multiple children, can really add up over time and be a flexible and efficient way to pass assets estate tax free to the next generation!


Things to consider...

The new Biden administration is considering making changes to some of the estate tax code including lowering the exemption back down to $3.5 or $5 million and increasing the tax to 45%. If those agenda items will pass is still to be determined but doing proper planning now can help alleviate some of the tax burden down the road.

Also, all Illinois residents are subject to a “state” estate tax. The allowable exemption on this asset transfer is much lower at $4 million but with a smaller tax rate of 16%.

Planning needs to start now for the federal AND state estate taxes if you could be subject to them down the road. If changes are made to the system, it will be better to have discussed this ahead of time and then be able to adjust an existing plan.

This information is not intended to be a substitute for specific individualized tax advice. All examples are hypothetical and are for illustrative purposes. We suggest that you discuss your specific tax issues with a qualified tax advisor.