Estate and gift taxes are imposed by the federal government on the transfer of property from person to another, either at death (estate tax) or while the giver of the property is still alive (gift tax).

Estate Tax

Estates are required to file a federal estate tax return if the value of the "gross" estate is above a certain dollar amount (for 2007, the amount is $2 million). The gross estate includes the value of all property in which the decedent had an interest at the time of his or her death -- including such items as real estate, stocks and bonds, mortgages, notes and cash, insurance on the decedent's life, and jointly owned property. If spouses own property in joint tenancy, and one dies, one half of the value of the jointly held property is included in the gross estate of the deceased spouse.

Estate Tax Exemptions

Personal Exemption. The "personal estate tax exemption" allows a certain amount (or all) of a deceased person's estate to transfer free of the estate tax. The personal exemption is currently $1.5 million, but this amount is scheduled to increase over the coming years until 2010, when the estate tax is set to be repealed. In 2011, the exemption will revert to $1 million unless Congress extends the repeal. Keep in mind that Congress may take further steps to change the personal estate tax exemption at any time, or even repeal the estate tax altogether prior to 2010.

Marital Deduction. A deceased person's estate can pass tax free to a surviving spouse, as long as the surviving spouse is a U.S. citizen and his or her interest in the estate is not a nondeductible terminable interest. A nondeductible terminable interest is an interest in the property that is held by someone other than the surviving spouse. This third party has some right or interest in the property once the surviving spouse's interest in the property ends (i.e. upon the death of the surviving spouse). The marital deduction cannot be applied to such property.

To understand how the marital deduction and personal estate tax reduction might work in practice, suppose Bob dies in 2004 leaving an estate worth $5 million. Putting aside community property issues for the moment, assume that his will dictates that $3 million go to his wife, and $2 million to his daughter Kate. In this situation, no part of the $3 million Bob leaves to his wife will be subject to the estate tax (as long as Bob's wife is a U.S. citizen and no nondeductible terminable interest exists). However, of the $2 million Bob leaves to Kate, $500,000 will be subject to the estate tax (the $2 million total less the first $1.5 million that is tax-free under the 2004 personal estate tax exemption).

Other deductions. Other deductions against the gross estate include certain administrative expenses, funeral expenses, claims against the estate, certain taxes and other indebtedness and charitable bequests.

Filing the Estate Tax Return

The executor, personal representative, or person in possession of the estate's assets must file the estate tax return within nine months of the decedent's death. The estate can apply for a six-month extension of time to file, but the taxes must be paid within nine months of the decedent's death. The time for payment of the estate tax may be extended in certain circumstances.

State Estate Taxes

Some states also impose estate taxes. The state in which the decedent lived may impose an estate tax, and states where real estate or personal property is located may also impose an estate tax. The law of each state having any connection to the property in question must be consulted in order to assess any tax consequences associated with the property transfer. A skilled estate planning or taxation attorney can help make such a determination.

Gift Tax

The gift tax is a tax on the legal transfer of property from one person to another, during the giving person's lifetime. Certain gifts are exempt from the gift tax. These include:

• Gifts valued at a dollar amount of $12,000 or less to any one individual in a single calendar year;
• Gifts to a spouse;
• Payment of tuition or medical expenses on behalf of someone else;
• Charitable contributions; and
• Certain gifts to political organizations.

In addition to the annual exemption for gifts valued at $12,000 or less, an individual may give away a total amount of $1 million during his or her lifetime. In other words, even if you never exceed the annual exemption limit for any given year, if the total value of all gifts you give during your life exceeds $1 million, you will need to pay a gift tax on the amount over that limit.

If a donor's gifts exceed the exemption amount, in most cases the donor must file a gift tax return. For example, if Dan gave Reese gifts totaling $9,000 in 2003, and gifts valued at $17,000 in 2004, a return must be filed by Dan for the gifts given to Reese in 2004, and taxes paid on $6,000 (the $17,000 total less the $11,000 annual gift exemption for those years). Usually, the donor is primarily liable for the payment of any federal gift tax. If the donor does not pay the tax, the recipient of the gift will be personally liable for the payment of the tax. The gift tax return is due on April 15th of the year following the calendar year in which the gift was given, so in the above example Dan would file his gift tax return in 2005. A donor may apply for an automatic four-month extension to file the gift tax return but the date for payment remains April 15.