Estate tax versus gift tax - what’s the difference?
The estate tax and gift tax are both taxes on the transfer of wealth, but they apply in different circumstances and are governed by different rules.
Here’s an explanation of each:
1. Estate Tax:
What it is: The estate tax is a tax on the transfer of a person's estate (assets, property, and money) after their death. It is levied on the total value of the estate (which includes all assets, such as real estate, investments, and personal property).
When it applies: The estate tax is triggered when a person dies and their estate exceeds the federal or state estate tax exemption limits.
Federal Estate Tax: In 2025, the federal estate tax exemption is $13.99 million for individuals and $27.98 million for married couples. If the total estate value exceeds these thresholds, estate tax applies to the amount above the exemption.
State Estate Taxes: Some U.S. states impose their own estate taxes with lower exemption limits (e.g., $1 million in Massachusetts).
Who pays: The estate itself pays the tax before assets are distributed to heirs. The executor of the estate is responsible for filing the estate tax return and paying the tax.
Tax Rate: The estate tax rate is progressive, ranging from 18% to 40% at the federal level, depending on the value of the estate above the exemption.
2. Gift Tax:
What it is: The gift tax is a tax on the transfer of money or property during a person's lifetime, without receiving something of equivalent value in return. This includes gifts to family members, friends, or others.
When it applies: Gift tax applies when a person gives a gift that exceeds the annual exclusion limit or lifetime exemption. The annual gift tax exclusion allows you to gift up to $19,000 (for 2025) to each recipient per year without triggering gift tax. If a gift exceeds this amount, the giver may need to file a gift tax return.
Lifetime Exemption: The lifetime exemption for gifts is the same as the estate tax exemption (e.g., $13.99 million for individuals in 2025). The total amount gifted during your lifetime above the annual exclusion counts toward this exemption. Once the lifetime exemption is used up, gift tax is applied.
Who pays: The giver (donor) of the gift is responsible for paying the gift tax, not the recipient.
Tax Rate: Gift tax rates are similar to estate tax rates, ranging from 18% to 40%.
3. Strategies to Minimize Gift and Estate Taxes
Annual Gift Exclusion: Make annual gifts of up to $19,000 per person to reduce the size of your taxable estate.
Lifetime Exemption: Utilize the $13.99 million lifetime exemption by gifting during your lifetime to reduce your estate’s value.
Gift Splitting: Married couples can split gifts, allowing them to give more to each recipient without exceeding the annual exclusion.
Charitable Donations: Donations to qualified charities are both estate tax-deductible and can reduce the taxable estate.
Life Insurance: Consider using life insurance to cover estate taxes, and structure policies through an Irrevocable Life Insurance Trust (ILIT) to remove the proceeds from the taxable estate.
Family Trusts: Use irrevocable trusts to remove assets from the estate for tax purposes, while still benefiting from them
Summary
Gift Tax: Imposed during the donor's lifetime on gifts above $19,000 per recipient. The lifetime exemption is $13.99 million.
Estate Tax: Imposed on the value of the deceased person's estate if it exceeds the $13.99 million exemption. California does not have its own estate or gift tax.
No State-Level Taxes in California: While California has no state-level gift or estate tax, it has property taxes and community property laws that could affect the estate of California residents.
Example Scenarios:
Scenario 1 (No Filing or Tax):
You give $18,000 to a friend in 2025. Since this is under the $19,000 annual exclusion, no gift tax return is required, and no gift tax is due.
Scenario 2 (Filing Required, No Tax):
You give $50,000 to a child in 2025. This exceeds the $19,000 exclusion by $31,000, so you must file a gift tax return (Form 709). However, since the gift falls under the lifetime exemption of $13.99 million, no gift tax is due, and the $31,000 will count against your lifetime exemption.
Conclusion:
In the U.S., the annual gift tax exclusion for 2025 is $19,000 per recipient. Gifts up to this amount do not require reporting or incur any gift tax. However, gifts exceeding this amount require filing a gift tax return (Form 709), but no gift tax may be due if the donor has not exceeded their lifetime exemption. The lifetime exemption for 2025 is $13.99 million.
in the United States, the lifetime gift exclusion is the same as the estate tax exemption. This is because the gift tax and the estate tax are part of a unified tax system that operates together, meaning that both gifts made during a person's lifetime and assets passed on at death are subject to the same lifetime exemption amount.
For 2025, the combined lifetime gift tax exemption and estate tax exemption amount is expected to be $13.99 million per individual. This means that you can transfer up to $13.99 million worth of assets either during your lifetime as gifts or upon your death as part of your estate, without incurring any federal gift or estate tax. However, once you exceed this amount, you will be subject to tax.
Here’s a breakdown of how it works:
Unified Gift and Estate Tax System
The Unified Gift and Estate Tax system means that there is a single exemption limit for both gifts made during your lifetime and assets passed on after your death. This system allows individuals to use their exemption amount (currently $13.99 million) over their lifetime for both gifts and estates combined.
Key Concepts:
1. Lifetime Gifts and Estate Transfers:
The $13.99 million exemption can be used for gifts made during your lifetime or for the transfer of assets upon your death (i.e., your estate).
If you give away $5 million in gifts while you're alive, the remaining exemption available for your estate at death will be $8.99 million.
Conversely, if you use $10 million of your exemption during your lifetime, your estate will have only $3.99 million of exemption available when you pass away.
2. Estate Tax:
The estate tax is applied to the value of the assets in your estate after you pass away, and if the value of your estate exceeds the $13.99 million exemption, the excess is subject to estate tax.
3. Gift Tax:
The gift tax is applied to lifetime gifts that exceed the annual gift exclusion of $19,000 (2025). If you give gifts to someone that exceed the annual exclusion, the excess counts against your lifetime exemption of $13.99 million.
4. Tax Rate on Exceeding the Exemption:
If you give away or transfer more than the $13.99 million exemption during your lifetime and at death combined, you will incur a gift tax or estate tax at a rate that starts at 18% and can go as high as 40% for very large estates.
Example of Using the Exemption:
Let’s assume you’re an individual with a $13.99 million exemption:
Scenario 1: Lifetime Gifts
You give $5 million worth of assets as gifts to your children during your lifetime.
The $5 million reduces your available lifetime exemption for estate tax purposes. Now, upon your death, only $8.99 million of exemption remains to be applied to your estate.
Your estate will be taxed if it exceeds the remaining exemption amount of $8.99 million.
Scenario 2: Estate Transfers
You transfer $14 million worth of assets upon your death.
Since $13.99 million of your lifetime exemption has already been used, your estate will owe estate tax on the $1 million excess, at the applicable tax rate.
Scenario 3: Combination of Lifetime Gifts and Estate Transfers
Over your lifetime, you give $3 million in gifts to your children.
Upon your death, your estate is worth $12 million.
You’ve already used $3 million of your $13.99 million lifetime exemption, so there’s $10.99 million of exemption remaining.
Your estate does not incur any estate tax because its value is within the remaining $10.99 million exemption.
Why Is the Gift and Estate Tax Exemption Unified?
The unified system prevents individuals from avoiding estate tax by giving away large sums of money during their lifetime. The idea is that whether you transfer assets during your lifetime (via gifts) or upon your death (via your estate), the total amount of wealth that you can transfer without tax liability is capped at the $13.99 million exemption.
