Understanding the intricacies of gift and estate tax is essential for individuals seeking to optimize their overall tax and financial planning. 

The requirements outlined in the tax code can significantly impact an individual’s gift and estate planning, and navigating these requirements effectively is crucial. In this blog post, we will delve into gift and estate tax concepts, explore their implications on individuals, and discuss how individuals can navigate the tax law by answering common questions. Individuals can make informed decisions and strategically manage their resources for long-term success by comprehensively understanding gift and estate tax through the help of a tax professional and through the help of valuation consultants when needed.

What types of taxes are levied on the transfer of an individual’s assets?

In the United States, three types of taxes may apply to transferring certain assets: inheritance tax, estate tax, and gift tax. Each tax has its own rules and exemptions, so it's important to understand which assets are subject to each tax.

Inheritance Tax: Inheritance tax is a tax imposed by some states on the transfer of assets from a deceased person to their heirs or beneficiaries. However, it's important to note that not all states have an inheritance tax, and those that do may have different rules and exemptions. In general, inheritance tax is levied on the value of the assets received by the beneficiaries, and the tax rate may vary depending on the relationship between the deceased and the beneficiary. Also, while the remainder of this article focuses on federal taxation, the same valuation concepts apply for both federal and state taxes.

Estate Tax: Estate tax is a federal tax imposed on the transfer of a deceased person's assets to their heirs or beneficiaries. It is important to note that estate tax only applies to estates that exceed a certain value, known as the federal estate tax exemption. As of 2023, the federal estate tax exemption is $12.92 million per individual ($25.84 million combined for a married couple). This means that if the total value of an estate is below this threshold, no estate tax will be owed. However, if the estate's value exceeds the exemption amount, the excess will be subject to estate tax.

Gift Tax: Gift tax is a federal tax imposed on the transfer of assets in excess of an annual exclusion per recipient ($17,000 in 2023) from one person to another without receiving anything in return or receiving less than the full value of the gifted assets. It aims to ensure that individuals cannot avoid estate taxes by giving away their assets before they pass away. When making gifts, staying within the annual exclusion amount set by the IRS is crucial. Annual gifts in excess of the exclusion count toward the $12.92 million exclusion amount discussed above.

How is the valuation of gifts and estates determined for tax purposes?

Valuing gifts and estates for tax purposes is important for tax planning and compliance. The Internal Revenue Service (IRS) has specific rules and guidelines in place to determine the value of gifts and estates, ensuring fair and accurate taxation.

When it comes to gifts, the value is determined at the time of the gift. The gift's fair market value (FMV) is used to establish its worth. FMV is the price that the property would sell for on the open market between a willing buyer and a willing seller.

For non-cash gifts, such as real estate or stock in a closely held (that is, non publicly-traded) business, the FMV is determined based on various factors like comparable sales, appraisals involving analysis of forecasted cash flows, or financial statements. It's important to note that in cases where the FMV cannot be easily determined, professional appraisals may be required.

In the case of estates, the valuation is typically determined by the date of the decedent's death. In some cases, an alternate valuation date six months after the date of death may be utilized. The selected valuation date establishes the value of all assets included in the estate. The FMV of each asset, such as real estate, investments, or personal property, is determined as of that specific date.

The valuation of estates involves the consideration of factors such as market conditions, appraisals, and professional opinions. It is crucial to support the FMV of each asset with a supportable valuation analysis to avoid any potential tax issues.

It's worth mentioning that there are certain exclusions and deductions available for both gifts and estates, which can help reduce the overall tax liability. However, these exemptions and deductions are subject to specific rules and limits set by the IRS.

What are the filing requirements for gift tax and estate tax?

Gift and estate tax filings are separate from income tax filings and have specific requirements and deadlines.

For gift tax, if a gift is made during the year exceeding the annual exclusion amount of $17,000 per recipient in 2023, the individual making the gift must file a gift tax return. However, no tax is due unless the total lifetime gifts exceed the lifetime exemption amount, which is $12.92 million per individual in 2023. It's important to remember that the lifetime exemption amount is subject to change as it is adjusted for inflation.

On the other hand, estate tax applies to the transfer of property at death. If the value of an individual's estate exceeds the estate tax exemption amount, which is also $12.92 million per individual in 2023, an estate tax return must be filed. Similar to gift tax, the estate tax exemption amount is subject to change.
It's important to consult with a tax professional or estate planning attorney to ensure compliance with all filing requirements and to take advantage of any available exemptions or deductions.

Are there any strategies to reduce the burden of inheritance tax, estate tax, or gift tax?

Yes, there are strategies that can help reduce the burden of inheritance tax, estate tax, or gift tax. These strategies often involve careful planning and consultation with tax professionals to ensure compliance with the law while maximizing tax savings. Here are a few commonly used strategies:

Annual Exclusion: Each year, an individual can gift a certain amount of money or assets to another individual without incurring gift tax. As of 2023, the annual exclusion is set at $17,000 per individual or $34,000 for married couples. By gifting assets up to the annual exclusion amount, you can reduce your taxable estate and potentially avoid gift tax altogether.

Lifetime Exemption: The federal government provides a lifetime exemption for gift and estate taxes. As of 2023, the exemption amount is set at $12.92 million per individual, or $25.84 million for married couples. By using this exemption wisely, one can transfer significant assets without incurring any gift or estate tax.

Charitable Giving: Donating assets to qualified charitable organizations can provide both tax benefits and the satisfaction of supporting a cause of one’s choosing. Charitable gifts are generally deductible for income tax purposes and can reduce the value of donor’s taxable estate.

Irrevocable Trusts: By creating an irrevocable trust, a donor can transfer assets out of their estate and potentially reduce their estate tax liability. Irrevocable trusts can be structured in various ways to meet one’s specific needs and goals.

The benefits of proper valuation and tax planning

Proper valuation of gifts and estates is essential to ensure accurate taxation and to avoid potential penalties or audits from the IRS. By understanding the rules and guidelines set by the IRS, and by working with professionals, individuals can effectively plan their tax strategies.

One of the key benefits of proper valuation is avoiding tax issues. Failing to provide a supportable, defensible valuation of non-cash assets, such as stock of a closely-held company, can lead to underreporting or overreporting their value, which can result in incorrect tax calculations. This can trigger audits or penalties from the IRS.

Individuals can ensure that their assets are properly appraised and valued by working with professionals specializing in valuations. These professionals have the expertise and knowledge to consider factors such as market conditions, historical company performance, and reporting requirements to determine the FMV of non-cash assets in a defensible and supportable way.

Proper valuation also allows individuals to plan their tax strategies strategically. By understanding the rules and limits the IRS sets, individuals can take advantage of exemptions and deductions available for gifts and estates.

Understanding the annual exclusion and lifetime exemption amounts is crucial for gift tax. Individuals can avoid filing a gift tax return when making gifts by staying within the annual exclusion amount. Additionally, individuals can avoid paying gift taxes by keeping track of the total lifetime gifts and ensuring they do not exceed the lifetime exemption amount.

Similarly, understanding the estate tax exemption amount is essential for estate tax purposes. Individuals can minimize their estate tax liability by planning ahead and taking steps to reduce the value of the estate. This can include strategies such as gifting assets during the individual's lifetime or utilizing trusts.

In conclusion, proper valuation and tax planning are crucial for individuals to navigate the complexities of gift and estate taxes. By working with professionals specializing in valuations and understanding the rules set by the IRS, individuals and those overseeing their estate planning can avoid penalties or audits and strategically plan their tax strategies. Individuals can maximize their long-term financial success and that of their heirs and beneficiaries by taking advantage of available exemptions and deductions. In short, don't overlook the importance of proper valuation and tax planning.

About The Expert

Kevin Cannon is a Principal in Opportune’s Valuation practice based in Houston. He has 19 years of experience performing business and asset valuations and providing corporate finance consulting. His specific experience includes valuations of businesses and intangible assets for purchase price allocations, impairment, tax planning, and portfolio valuation purposes for companies in various industries, including upstream, oilfield services, and industrial manufacturing.