The estate tax and the gift tax are tied together. Tax regulations are subject to change, but as of 2013, estate tax only applied if the deceased left assets worth at least $5.25 million. If the deceased made large gifts during his lifetime he could use the same exemption to avoid tax on the gifts, but that can make the estate more vulnerable to taxation.
Individuals can give away a certain amount each year without paying gift tax. The limit rises with inflation. In 2013 it was $14,000 per recipient, or $28,000 if spouses give a joint gift. For example, if the deceased gave $12,000 in 2013 to each of his children and $5,000 to each grandkid, he owed no gift tax. If he gave one child $30,000, he owed gift tax on $16,000. Paying tuition or medical expenses aren't taxable ever, provided the money goes straight to the school or hospital.
An individual can make substantial taxable gifts without it affecting his tax bill. He can block the taxes by invoking the $5.25 million exemption, known as the unified tax credit. If he spends, for example, $50,000 in one year on taxable gifts, he files Form 709, the gift tax form, with Form 1040. If he doesn't want to pay gift tax, he can use the form to claim the credit, but using $50,000 of the credit would reduce his estate's tax exemption to $5.2 million.
If the deceased gave gifts that stayed below the gift-tax threshold, gift-giving may actually reduce the estate tax. For example, if he had an estate valued at $5.4 million -- above the exemption threshold of $5.25 million -- and gave $10,000 a year for 10 years to each of three adult children, that's $300,000 in assets given away. That would cut the estate down to $5.1 million, which is below the estate tax threshold. As most Americans don't leave enough to trigger estate tax, this isn't an issue with most estate planning.
If the deceased left everything to his spouse, estate tax isn't an issue. Spousal inheritance is exempt from estate tax, so even if the deceased used up all of the unified credit avoiding gift tax, it won't make a difference. If the deceased didn't use all the unified credit, his spouse can add it to her own credit. If the deceased claimed, for example, $4 million of his unified credit, that leaves $1.25 million. The spouse's estate would have to exceed $6.5 million before paying estate tax.
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