Federal transfer taxes include (1) the federal gift tax and federal estate tax and (2) the federal generation-skipping transfer tax (GSTT).
You need a basic understanding of how the gift tax system works to minimize gift tax liability. Under the gift tax system, you are allowed a $5.25 million lifetime gift tax applicable exclusion amount that reduces your gift tax liability (any gift tax applicable exclusion amount you use during life effectively reduces the applicable exclusion amount that will be available at your death). Also, you are currently allowed to give $14,000 per donee gift tax free under the annual gift tax exclusion. Further, certain other types of transfers can be made gift tax free. You need to understand what these types of transfer are and how they work to take full advantage of them.
You need a basic understanding of how the estate tax system works for several reasons:
Not surprisingly, the Internal Revenue Service (IRS) wants to impose a tax on property as it is passed from generation to generation at each and every level. The purpose of the GSTT is to keep individuals from avoiding estate tax by skipping an intermediate generation. A flat tax rate equal to the highest estate tax then in effect is imposed on every generation-skipping transfer you make over a certain amount. Currently, some states also impose their own GSTT. You should check with an attorney or your state to find out what may be subject to your state's GSTT, and how and when to file a state GSTT return.
States also impose their own death taxes. You should be aware of what the death tax laws are in your state and how they may affect your estate. There are three types of state death taxes: (1) estate tax, (2) inheritance tax, and (3) credit estate tax (also called a sponge tax or pickup tax). Some states also impose their own gift tax and/or generation skipping transfer tax.
State estate tax is imposed on property you transfer to others at your death, much like federal estate tax. The state estate tax calculation for most states is similar to the federal calculation. Some states impose a credit estate tax (also referred to as a sponge tax or pickup tax).
Unlike estate tax, the inheritance tax is imposed on your beneficiary's right to receive your property. Tax is due on each beneficiary's share of your estate. Beneficiaries are grouped into classes (generally based upon their familial relationship to you) and are taxed accordingly. Although inheritance tax is due on each heir's share of your estate, it's your personal representative who writes the check from your estate to pay it.
In the estate planning context, you should also be aware of three federal income tax considerations:
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