Estate taxes can be significant, especially in estates valued at over five million dollars. Some individuals may want to give their offspring a part of their estate before they die, but do not want their gifts to be subject to a federal gift tax. It may be possible to give a child an early inheritance that is not subject to taxation.
Since the early 19th century, the U.S. government implements a form of estate tax for its citizens. Originally imposed as a way to generate revenue during wartime, the tax became standard and constant in the early 20th century. Although the estate tax rate ranges from one percent to 70 percent, as of the time of publication, it is set to 35 percent of any amount over five million dollars. Any tax needing requiring payment is the responsibility of the estate's executor or trustee, not the recipient of the inheritance.
Sometimes a parent may give a significant monetary gift to a child and call it an "early inheritance." For tax purposes, however, there is no such thing as an early inheritance and the Internal Revenue Service, or IRS, considers the transaction simply as a "gift." The amount is subject to a gift tax if it is over the non-taxable limit. As with an estate tax, the gift tax is the responsibility of the donor, not the recipient.
One way some people get around the gift tax is by making the gift in the form of a testamentary advance. For all intents and purposes, this advance is a loan to the recipient, and deducts from the recipient's future inheritance. You'll typically need to consult with an estate attorney before proceeding with a testamentary advance because the IRS requires specific documentation of the loan. You must also calculate the market-rate interest against the loan for repayment to the estate.
At the time of publication, an individual may make a non-taxable gift to any other individual for up to $13,000 per year. If a parent wants to give an "early inheritance" gift to a child, and wants it to be more than $13,000, he can do so, but any overage is subject to a gift tax. Some donors avoid the gift tax by giving $13,000 to the child, another $13,000 to the child's spouse, and additional money to each of the child's offspring. The donor must report these gifts on his federal income tax return.
The IRS considers estate taxes and gift taxes linked, and calls their relationship a "unified credit." The donor may opt not to pay the gift tax at the time of the gift. In this case, the tax deducts from the five million dollar no-tax cap on the donor's estate once he dies. This means that if throughout his lifetime the donor gives away two million dollars over the annual non-taxable gift limits, an estate tax will levies against any value of his estate over three million dollars. On the other hand, if he opts to pay the gift tax upon making the gift, the amount of the tax paid during his lifetime credits back to the cap on his estate.
- Kay Bell: Estate Tax and Gift Tax Amounts
- Internal Revenue Service. "Frequently Asked Questions on Gift Taxes." Accessed Jan. 14, 2020.
- Internal Revenue Service. "Frequently Asked Questions on Gift Taxes for Nonresidents not Citizens of the United States." Accessed Jan. 24, 2020.
- Internal Revenue Service. "What's New - Estate and Gift Tax." Accessed Jan. 5, 2020.
- Internal Revenue Service. "26 CFR 601.602: Tax forms and instructions." Accessed Jan. 13, 2020.
Micah Rubenstein has been writing professionally since 1985. He was the editor of the online publication GrailWorld Magazine, the host and producer of the weekly "Message In Music" radio series and a former professor at Kenyon College in Gambier, Ohio. He teaches at Columbus State Community College and Granite State College in New Hampshire. He holds a Bachelor of Arts in music from Brown University.