Gift and estate taxes

What Is Gift and Estate Taxes?

Gift and estate taxes are levies imposed by the government on the transfer of wealth, either during a person's lifetime or at their death. These taxes fall under the broader financial category of taxation and wealth management, designed to collect revenue and, to some extent, to address wealth concentration. While "gift taxes" apply to transfers of money or property made during life, "estate taxes" are imposed on the total value of a deceased person's gross estate before it is distributed to beneficiaries. Understanding gift and estate taxes is crucial for effective long-term tax planning and intergenerational wealth transfer.

History and Origin

The concept of taxing wealth transfers has a long history in the United States, often emerging during times of national need. Early forms of death duties, such as stamp taxes on wills, were introduced to fund conflicts like the undeclared naval war with France in 1797 and later the Civil War in 1862 and the Spanish-American War in 1898. These early taxes were typically temporary and repealed once the funding emergency subsided. The modern federal estate tax, however, became a permanent fixture with the enactment of the Revenue Act of 1916, following the ratification of the 16th Amendment which allowed for income taxes. Sixteen years later, a gift tax was enacted in 1932 to prevent individuals from avoiding estate taxes by transferring wealth during their lifetime. This unified system of federal transfer taxes has seen numerous adjustments over the decades, reflecting ongoing debates about wealth distribution and government revenue needs.²¹, ²²

Key Takeaways

• Gift and estate taxes are federal levies on the transfer of wealth, either as gifts during life or as part of an estate at death.
• Most individuals will not owe federal gift or estate taxes due to generous annual exclusions and a substantial lifetime exemption.
• The person making the gift (donor) is typically responsible for paying the gift tax, while the estate itself pays the estate tax.
• Strategic wealth management and estate planning are essential for minimizing potential gift and estate tax liabilities.

Interpreting the Gift and Estate Taxes

Interpreting gift and estate taxes primarily involves understanding the applicable exclusion amounts and tax rates. The Internal Revenue Service (IRS) sets an annual exclusion for gifts, which is the amount an individual can give to any other person in a calendar year without incurring gift tax reporting requirements or using up their lifetime exemption. For 2025, this annual exclusion is $19,000 per recipient.¹⁹, ²⁰ Any gifts exceeding this amount are considered taxable gifts, but they generally do not result in immediate tax payment unless the cumulative total of such gifts, along with the value of the decedent's estate, exceeds the much larger lifetime exemption. The federal estate tax exemption, which is unified with the gift tax lifetime exemption, is $13.99 million per individual in 2025.¹⁶, ¹⁷, ¹⁸ This means that an individual can transfer a significant amount of wealth over their lifetime and at death before any federal gift or estate tax becomes due. The estate tax rates themselves are progressive, ranging from 18% to 40% on the portion of the estate or gifts that exceed the lifetime exemption.¹⁴, ¹⁵

Hypothetical Example

Consider an individual, Alice, who wishes to gift money to her three children in 2025. The annual gift tax exclusion for 2025 is $19,000 per recipient.

1. Gift 1: Alice gives her daughter, Beth, $19,000. This gift is within the annual exclusion, so no gift tax return is required, and it does not reduce Alice's lifetime exemption.
2. Gift 2: Alice gives her son, Charles, $25,000. This gift exceeds the annual exclusion by $6,000 ($25,000 - $19,000). While Alice will need to file a gift tax return (IRS Form 709) to report this gift, she will not immediately owe gift tax. Instead, the $6,000 excess reduces her $13.99 million lifetime exemption by that amount.
3. Gift 3: Alice gives her youngest child, David, $10,000. This gift is also within the annual exclusion, similar to Beth's gift, and has no immediate tax implications.

Even if Alice continued to make gifts exceeding the annual exclusion over many years, she would only begin to pay federal gift tax once the cumulative total of these excess gifts surpassed her substantial lifetime exemption. This framework allows for significant tax-free wealth transfer.

Practical Applications

Gift and estate taxes play a significant role in estate planning and wealth transfer strategies, particularly for high-net-worth individuals. They influence decisions regarding how assets are structured, passed down, and even whether certain assets are sold during a lifetime. For instance, the use of various legal structures, such as a trust, can be part of a strategy to manage potential estate tax liabilities.

Executors of estates are responsible for valuing the decedent's assets and liabilitys, identifying deductions, and if the gross estate exceeds the federal exemption, filing IRS Form 706, the United States Estate (and Generation-Skipping Transfer) Tax Return. This form is used to calculate and report the estate tax owed.¹¹, ¹², ¹³ Beyond direct taxation, these taxes also encourage charitable giving, as charitable donations made during life or at death are generally exempt from gift and estate taxes. This provides an incentive for philanthropic transfers.¹⁰

Limitations and Criticisms

Despite the high exemption thresholds that mean only a small percentage of estates face federal gift and estate taxes, these taxes have historically been a subject of significant debate. Critics often argue that they constitute "double taxation," as the wealth being transferred has already been subject to income tax or capital gains tax. Concerns are also raised about their potential impact on family-owned businesses and farms, which may face liquidity issues if significant assets must be sold to cover estate tax liabilities.

Conversely, proponents argue that gift and estate taxes are an important tool for progressive taxation, ensuring that accumulated wealth contributes to public revenue and helps to mitigate economic inequality. Research by the Federal Reserve, for example, has analyzed the composition of estates, noting the prevalence of unrealized capital gains and evaluating how different taxation policies at death might impact revenue and tax burdens across wealth levels.⁹ The ongoing political discussion often centers on the appropriate exemption levels and tax rates, balancing revenue generation with economic incentives and perceived fairness.

Gift and Estate Taxes vs. Inheritance Tax

While often used interchangeably by the public, "gift and estate taxes" and "inheritance tax" represent distinct forms of taxation on wealth transfer. The fundamental difference lies in who pays the tax.

• Gift and Estate Taxes: These are taxes on the transferor of wealth. The federal gift tax is paid by the donor (the person giving the gift), not the recipient. Similarly, the federal estate tax is levied on the deceased person's estate itself before assets are distributed, with the executor responsible for its payment from the estate's assets.
• Inheritance Tax: This is a tax on the recipient of wealth. It is levied directly on the beneficiary who receives money or property from a deceased person's estate. The tax rate often depends on the relationship between the beneficiary and the deceased, with closer relatives typically facing lower rates or exemptions. Currently, the U.S. federal government does not impose an inheritance tax; it operates solely with gift and estate taxes. However, some individual states do levy an inheritance tax, separate from any federal estate tax.

Confusion often arises because both types of taxes deal with transfers of wealth after death, but understanding who bears the tax burden clarifies their distinct nature.

FAQs

What is the annual gift tax exclusion?

The annual gift tax exclusion is the amount of money or value of property you can give to another individual each year without having to report the gift to the IRS or use up any of your lifetime gift and estate tax exemption. For 2025, this amount is $19,000 per recipient.⁷, ⁸ You can give this amount to as many people as you wish.

Do I have to pay gift tax if I give someone more than the annual exclusion?

Not necessarily. If you give more than the annual exclusion to an individual in a year, you must file IRS Form 709, the United States Gift (and Generation-Skipping Transfer) Tax Return, to report the gift.⁶ The amount exceeding the annual exclusion will then reduce your lifetime gift and estate tax exemption. You will only owe gift tax if your cumulative taxable gifts plus your gross estate at death exceed the lifetime exemption, which is a much larger amount ($13.99 million per individual for 2025).⁵

Who pays the gift or estate tax?

For gift tax, the person making the gift (the donor) is generally responsible for paying the tax. For estate tax, the tax is paid by the deceased person's estate before assets are distributed to beneficiaries. The executor of the estate is responsible for filing the necessary tax returns, such as IRS Form 706, and ensuring the tax is paid.³, ⁴

Are there any gifts that are exempt from gift tax, regardless of amount?

Yes, certain gifts are exempt from gift tax and do not count against your annual exclusion or lifetime exemption. These include: gifts to your spouse (if they are a U.S. citizen), payments made directly to an educational institution for tuition, payments made directly to a medical provider for someone's medical expenses, and gifts to qualified political organizations.¹, ² Consulting with a financial advisor specializing in estate planning can help navigate these complexities.