Unit 18 - Estate & Gift Taxes For Individuals Flashcards
What is an estate?
A separate legal entity created when a taxpayer dies
What is estate tax?
What is it not??
A tax on the transfer of assets or property from an individuals estate to a decedents beneficiaries after death
Sometimes referred to as a death tax or an inheritance tax
And a state tax is not an income tax
Estate tax exemption
Up to $12,920,000 per decedent is free of estate tax.
Anything additional above that is taxable at a progressive rate
Starts at 18% and rises to 40%
Amount transferred tax-free to a spouse do not count towards the exclusion amount
2023 annual gift tax exclusion
$17,000
What is the difference between an estate tax and a gift tax?
Estate tax applies to transfers of the decedents property after death
The gift tax applies to transfers made while a person is alive
Personal representatives, executors, and administrators
What’s the difference?
A personal representative is a living person appointed by the courts to administer and estate after taxpayer has died
Executors are appointed when the decedent has a will
Administrators are appointed when the decedent dies without a will
Before estate assets are distributed to beneficiaries… need to determine
Any estate tax liability that needs to be paid
If the assets are distributed to beneficiaries before taxes are paid, the beneficiaries or the executor may be held liable for the tax debt
After a taxpayer dies, what tax returns need to be filed by the personal representative of the estate
Form 1040 – final income tax return for the decedent for income received before death
Form 1041 – US income tax return for estates and trust
Form 706 – United States estate and generation-skipping transfer tax return
How are the tax returns signed
The personal representative or executor must sign each required return
Signed as – personal representative
IRS form 56
Notice concerning fiduciary relationship
First and executor would request an EI for the estate
Then complete form 56 to establish authority as the executor over an estate
Will ensure the executor will receive any important notices from the IRS
IRS form 56 – joint return
The final income tax return is a joint return – surviving spouse, signs as surviving spouse
There is no need to file form 56 for the final 1040 return
Fees paid to an executor, personal representative, or trustee
Need to be included as gross income on their tax returns
If not in the business of being an executor (relative) The fees are reported on their individual form 1040 as other income on schedule one.
A personal representative or executors liability to an estate
They cannot be held liable if an insolvent estate does not have enough assets to cover the income taxes due or debts
But they must be sure that income taxes are paid before any assets are distributed to beneficiaries or they could be liable
Final income tax return
What form?
When is it due and what is the filing requirement?
Filed on the same form that would’ve been used if still alive – form 1040
Deadline is April 15 of the year following the taxpayers death
Personal representative must file the final income tax return, and any returns not filed for proceeding years
Decedents final tax return – rules for deductions
The decedents year of death is not treated as a short year (able to receive full standard deduction and EITC)
Can claim the same deductions that would apply for any individual taxpayer
IRD
Income in respect of a decedent
Taxable income that was earned, but not received by the time of death
IRD is not taxed on the final return of the deceased taxpayer
IRD is reported on the tax return of the person (or entity) that receives the income.
IRD paid directly to a beneficiary
Reported on the beneficiaries income tax return form 1040
IRD received by the estate itself
Reported on the estates form 1041
IRD tax nature
Retains the same tax nature that would have been applied if the disease taxpayer were still alive
Example – short term gain
There is no step up in basis for IRD items
Self-employment – partnership income
Will include the distributive share of a partnerships, income or loss through the end of the month in which death occurred
Wages paid to a deceased employees estate, or executor in the year of death
Not subject to income tax withholding
But employment, taxes, such as FICA, must be withheld
Wages paid to a deceased employees estate, or executor after the year of death
Generally, not subject to withholding for any federal taxes, including FICA
Forms of IRD
Unpaid salaries, wages, or bonuses
Deferred compensation benefits
Dividends declared before death paid after death
Accrued but unpaid interest, dividends and rent
Retirement plan distributions not yet received before death
On sale of property sold not collected until after death
Self-employment accounts receivable
When is IRD included in the decedents estate and subject to estate tax?
May happen with a very wealthy person
If the estate was large enough to be subject to the estate tax – result in double taxation
- at the estate level
- when beneficiary receives income
If this happens, the beneficiary can use the IRD deduction on schedule a if itemizing - in same year, they received the income
IRD deduction is not permitted if the estate isn’t subject to estate tax
Form 706
What is it?
Due date?
Calculation?
The estate tax return
Do nine months after the death of the decedent – a six month extension is allowed
Only needs to be filed if the estate exceeds $12.92 million . - after deductions for debt/expenses
Which includes any value of lifetime taxable gifts
Estate tax = 18% to 40%
Minus any gift taxes paid
Assessment period for estate tax
Three years after the due date for a timely filed estate tax return
Four years for transfers from an estate
DSUE
Deceased spousal unused exclusion
A surviving spouse can add any unused exclusion of a deceased spouse to their own estate exclusion
A portability election must be made to claim the DSUE - Portability is not automatic.
Form 706 must be filed in order to make the DSUE election, even if no estate taxes owed
The surviving spouse must be a US citizen – not available to non-resident alien spouses
Nonresident aliens – estate tax
What is the threshold?
What is the estate tax return?
$60,000
Only subject to two estate tax for assets located within the US
Form 706 – NA is used for nonresident aliens
Form 1041
The annual income tax return for Estates and trust
Investment assets will usually continue to earn income after a taxpayer has died, this income, such as rents, dividends, and interest, must be reported
Most estates are administered and distributed within 12 to 18 months
But some can drag on for years for probate litigation, dispute about a will or between the heirs, etc.
This return needs to be filed each year until the estates assets are distributed, and the estate is dissolved
When can a taxable estate be closed?
When the estate obtains an IRS transcript showing the acceptance of the estate tax return
Or it receives a final closing letter from the internal revenue service
The following items are reported on form 1041
Current income and deductions, including gains and losses from the disposition of the entities property – excluding certain items, such as tax exempt interest
A deduction for income held for future distribution or distributed to the beneficiaries (income distribution deduction)
Any income tax liability
How are expenses of administering the estate deducted?
Either from the estate income on form 1041 and determining its income tax
Or from the gross state on 706 in determining the estate tax liability
Cannot be claimed for both purposes
Estates - schedule K –1
Used to report any income that is distributed or distributable to each beneficiary and is filed with form 1041
With a copy given to the beneficiary
The beneficiary individual (not an entity or charity) would report the distributive income on form 1040 schedule E
Estates and trust – tax credits
Allowed some of the same tax credits that are allowed to individuals
But not the CTC or the EITC
Estates and trust – NIIT
Just like individual taxpayers, estates and trust are subject to the net investment income tax
Reported on form 8960 – net investment tax for individuals, estates, and trust
$14,450 threshold
Form 1041 due date
The 15th day of the fourth month, following the end of the entities tax year
Automatic extension of 5 1/2 months if the form 7004 is filed by the original due date
The tax year may be a calendar or a fiscal year for an estate, subject to the election made at the time the first return is filed
An election will also be made on the first return as to the accounting method – cash or accrual for reporting the estates income
Form 1041 is required to be filed for any domestic estate that has…
- Gross income for the tax year of $600 or more.
Or
- A beneficiary who is a nonresident alien for any amount of income.
If the estate has no income, producing assets, and generates no income, no income tax return is necessary
The gross estate
What is it?
What does it include?
What does it not include?
Is based upon the FMV of the decedents property – not necessarily equal to the assets cost
Includes :
The FMV of all tangible and intangible property owned partially or outright by the decedent at the time of death
Life insurance proceeds payable to the estate, for policies owned by the decedent, payable to the heirs
The value of certain annuities or survivor benefits, payable to the heirs
The value of certain property that was transferred within three years before the decedents death
Does not include :
Property owned by the decedent, spouse or other individuals
Lifetime gifts that are complete – so that no control over the gifts was retained
Form 706 – gross estate deductions
What is deductible?
What is not deductible?
After calculating the gross estate – certain deductions or reductions can be made to determine the taxable estate
These deductions may include :
- Funeral expenses paid from the estate
- Administrative expenses for the estate – court fees and legal cost if not already deducted on form 1041
- Debts Owed at the time of the individuals death
- Marital deduction – value of property passing to a surviving spouse
- Charitable deduction – value of property passing to eligible charities
- State death tax deduction, inheritance, or estate taxes paid to any state
- Property taxes, but only if they accrue under state law prior to the death.
The following items are not deductible from the estate :
- Federal estate taxes paid.
- Alimony paid after the taxpayers death – treated as distributions to a beneficiary.
Special rule for medical expenses
Dad’s can be deducted from the total value of the estate on the estate tax return
Any outstanding medical expenses at time of death – considered liabilities of the estate
Paid within one year of death …
Executor has option to treat it as if it was paid when incurred and deduct the expenses on form 1040 instead of on potentially form 706
Results in a better tax outcome to the estate
The marital deduction
Allows spouses to transfer an unlimited amount of property to one another during their lifetime or at death without being subject to a state or gift taxes
To qualify, the spouse receiving the assets must be a US citizen and must have outright ownership of the assets after the passing of the decedent
Not allowed if the spouse is not a US citizen, even if they are a legal resident - noncitizen spouses can only receive $175,000 tax-free
How are inheritances taxed?
Inheritances are generally not taxable to the beneficiary
Beneficiary may be responsible for related estate tax liability that has not been satisfied
Retirement plans, such as IRA accounts, are different. Any tax deductible contributions would still be subject to income taxes, but no early withdrawal penalty.
Basis of estate property
While cash inheritances are not subject to federal income tax, money received from the sale of inherited property may be taxable
The basis of property inherited is one of the following
FMV On date of death
FMV on an alternate valuation, date, if elected
The value under a special use valuation method for real property used in farming or another closely held business, if elected
The decedents adjusted basis in land to the extent of the value excluded from the taxable estate as a qualified conservation easement
Jointly owned property
Property jointly owned by a decedent and another person – will be included in full in the decedents gross estate
Unless it can be shown that the other person originally owned or contributed to the purchase price
The surviving owners new basis of property that was jointly owned must be calculated :
- surviving owners basis + value of part of property included in decedents estate - any deductions for depreciation allowed to the surviving owner for his portion
Property jointly held between spouses
1/2 of the properties value is included in the gross estate
There is a step up in basis for that one half
The other half is stated at the surviving spouses cost basis, net of any deductions for depreciation allowed on that half
If property is a community property state – entire value will receive a step up in basis to FMV
GST
What is it?
Who does it apply to?
How is a calculated?
Exclusion amounts, and tax rate
Generation-skipping transfer tax
May apply to gifts made during taxpayers lifetime, or after a taxpayers death – made to skip persons
A person is usually a grandchild or someone who is more than 37 1/2 years younger than the person making the gift
GST is assessed when the property transfer is made
Based on the amount, transferred to skip persons after subtracting allocated portions of the donors available GST exemption
GST exemption is the same as the estate tax basic exclusion amount
GST tax rate is the estate tax rates – maximum of 40%
GST is imposed separately and in addition to the estate and gift tax
Gift tax
Imposed on the donor, not the receiver, of the gift - The recipient typically owes no tax and doesn’t have to report the gift unless it comes from a foreign donor
Special arrangements – Donnie may agree to pay the tax instead of the donor
Can apply to both cash and non-cash gifts
The following gifts are not taxable and do not have to be reported
- Gifts to an individual that do not exceed the annual exclusion amount – $17,000 per donee
- Tuition or medical expenses paid directly to an institution.
- Unlimited gifts to a spouse – as long as spouse is a US citizen
- Gifts to a political organization for its own use.
- Gifts to a qualifying charity.
- A parent support for a minor child. Including support required as part of a legal obligation, such as a divorce decree.
How is gift tax reported
Filing requirements
A gift tax return – form 709
Must be filed if :
- A taxpayer gives more than the annual exclusion amount to at least one individual – except to a US citizen spouse.
- Taxpayer split gifts with a spouse.
- A taxpayer gives a future interest to anyone other than a US citizen spouse.
Gift tax return due date
Generally, due by April 15 of the following year
If donor dies during the year – deadline may be the due date (with extensions) for the estate tax return, if earlier than April 15 of the following year
If taxpayers extend their form 1040, deemed to have extended their gift tax returns also
If tax does not extend their individual return – the gift tax return can be extended separately using form 8892 to provide an additional six months to file 709
Present interest VS future interest
Present interest – the donee has all immediate rights to the use, possession, and enjoyment of the property or income from the property with no strings attached
Future interest – donee’s rights to the use, possession, and enjoyment of the property or income from the property will not begin until some future date
Gift splitting by married couples
If either spouse makes a gift to another person, the gift can be considered as being 1/2 from one spouse and one half from the other spouse
Allows a married couple to give up to $34,000 to a single individual without making a taxable or reportable gift
Both spouses must consent to split the gift
If a couple split a gift, each spouse must file their own gift tax return
Basis of property received as a gift
Determining gain or loss on a subsequent disposition of property received as a gift - must consider
The gifts adjusted basis to the donor before it was given to the taxpayer
The gifts FMV at the time it was given
Any gift tax actually paid on the appreciation of the properties value while held by the donor
When the fair market value of the gift is the same as or higher than the donors adjusted basis for the gift before it was transferred
The donees bases will be the same as the donors adjusted or transferred basis
When the fair market value of the gift is lower than the donors adjusted basis at the time of transfer
When the recipient sells the gifted property
any gain will be calculated based on the donors adjusted basis
Any loss will be calculated using the FMV
If sold for a price between the FMV and gifted basis – no gain or loss recognized
The applicable credit
Also referred to as the unified credit
The combination of the lifetime gift, tax, exclusion, and estate tax exclusion
The estate tax exclusion is $12.92 million
The applicable credit amount for 2023 is $5,113,800.
Any portion of the applicable credit amount used to avoid payment of gift taxes, reduces the amount of credit available in later years that can be used to offset gift or estate taxes
Taxpayer exceeds the annual gift tax exclusion amount in any year – can choose to either pay the gift tax or take advantage of the unified credit to avoid paying the tax in the current year
