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Davis Brown Tax Law Blog

Tax Law Blog: Basics of Estate Tax and Gift Tax - October 15, 2012

With the looming end of the current tax cuts, estate tax and gift tax have both become hot topics in the news, which may leave some of you with questions on just how estate taxes and gift taxes work. Here is some basic information.

  • Who pays estate tax? The estate tax is just that, a tax on the estate. The person receiving the property is not taxed, the estate is responsible. (Indirectly, you may "pay" in the sense that the amount in the estate is reduced from paying the tax, meaning you may receive less).
  • What is the difference between inheritance tax and estate tax? Iowa has an inheritance tax on certain transfers at death. If you leave property to your children, grandchildren or parents, there is no inheritance tax. If you leave property to people outside your direct bloodline, like siblings, nieces/nephews, or friends, that property is subject to inheritance ranging from 5% to 15%. This tax is paid by the individual receiving the property, unless you direct otherwise in a Will. When giving away property other than cash (like land), consider the ability of the recipient to pay the tax, which could be significant depending on the value of the property.
  • Does it affect my income taxes if I receive a gift? No, regardless of whether it was a gift from someone while still living, or received under someone's Will, the amount received is not considered income.
  • Does it affect my taxes if I give a gift? Maybe, but not if you do it right. You can gift up to $13,000 per person, per year, with no tax consequences (Annual Exclusion Gifts). If you give more than $13,000 to a single person, the amount over $13,000 is subject to gift tax. However, in 2012, each person has a unified credit of $5.12 million, meaning each person can give away $5.12 million either by gift or at death, without federal tax. By filing a gift tax return, you can use part of that credit during your life instead of paying gift tax. (Keep in mind that reduces the amount in your estate that can pass free from tax at your death). Alternatively, you will need to pay gift tax ranging from 18% to 35%.
  • Why are estate taxes and gift taxes such a hot topic currently? The current exemption amounts and tax rates are set to expire on December 31, 2012.  If Congress doesn't act, on January 1, 2013, the unified credit drops from $5.12 million to $1 million, and the estate tax rate jumps from 35% to 55%

This is a very basic overview of estate taxes and gift taxes, but hopefully enough so you can understand some of the discussions that are likely to come after the election as Congress debates what to do with the future tax rates and exemption amounts.