Federal Gift and Estate Tax Law in a Nutshell

Until the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRAA), all transfers of money or property by gifts or by will were subject to a single federal unified gift and estate tax system. Under the old law, each person who died was entitled to a federal tax credit (like a coupon) to use to pay a portion of his or her estate tax (if any). This tax credit was available to offset a portion of gift tax as well. The gift and estate tax credit equivalent is the amount of money for which the credit would pay the full gift or estate tax. It is essentially the amount exempted from those taxes. The new law created two different exemption amounts for the gift tax and the estate tax beginning in 2004 and eliminates the estate tax after 2009. However, the provisions of EGTRAA will automatically sunset after 2010 unless Congress specifically renews it.

Unlike the estate tax, the tax on lifetime gifts will not be repealed, and the amount of the exemption for lifetime gifts increased to only $1 million and remains at that level. This will have a significant effect on tax planning for property transfers because the size of the tax-exemption available will depend on choosing a lifetime or testamentary transfer.

Until the estate tax's scheduled end on January 1, 2010, the maximum rate on the taxable portion of gifts and estates will be decreased slightly over the next few years.

These changes are set forth in the table below:

Beware: There is a "self-repeal" feature in the tax law. All the benefits automatically end after 2010. Unless the provisions of the 2001 Act are renewed, the law will expire and the old rules will go back into effect! Many advisors believe that some sort of congressional compromise is likely, so that not all the benefits of the 2001 law will end after 2010.

Therefore, it may be wise to consult your legal, tax, and financial advisors to determine how the scheduled tax changes may affect your estate plan. Schedule regular plan reviews and meet with your advisors whenever there is a change in your financial situation. The law is in a state of uncertainty, and much is likely to depend on the year in which a particular transfer is made—whether by gift or due to the death of the estate owner.

Lifetime gifts must be reported by filing a gift tax return and paying the gift tax or using all or part of the gift tax credit unless the gift qualifies for exclusion (see below). Whatever portion of the gift tax credit is not used to pay tax on lifetime gifts is available to pay estate tax at death. The amount of the credit is the same for each person and can be allocated over multiple gifts until it is used up.

You may use your exemption amount to shelter from tax the first $1 million of your estate that you transfer by gift during life or $2 million at death. Tax rates on the remainder of your estate begin at 41 percent and go to 46 percent in 2006, then decline to 45 percent in 2007 through 2009. If a person makes a taxable gift of $100,000, he or she may use part of the exemption to avoid paying the tax on the gift. The balance of the exemption would cover the tax due on the next $900,000 ($1 million exemption reduced by $100,000 to avoid tax on the gift).

Fortunately, there are ways to avoid some or all of your potential gift and estate tax liabilities if you plan appropriately, taking advantage of the breaks provided by law. But significant changes in the law seem likely. More than ever, it will be worthwhile to get professional estate planning advice.