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Estate and Gift Taxes

Estate taxes are taxes levied on estates which are valued at over a certain amount as of the date a person dies. The portion of the estate that exceeds the exclusion amount is taxed.  There is a federal estate tax and many individual states have a state-level estate tax.  Virginia has repealed its state-level estate tax, but the federal estate tax does apply to the estates of Virginia residents who have died. The current tax rate starts at 18% and quickly rises to 40% based on the size of the taxable estate. As of 2021, each individual is entitled to a lifetime exclusion of $11.7 million and, as it goes up with inflation, the excluded amount will continue to change.  Current laws regarding the lifetime exclusion amount will sunset in 2026, unless current proposed legislation is enacted beforehand, which aims to reduce the lifetime exclusion significantly.

We often hear the current exclusion amount expressed as "$11.7 million or $23.4 million for a couple". This expression is a reflection of the portability laws concerning the estate tax exclusion. In the past, the exclusion was personal, and an unused amount could not be passed on to a spouse. For this reason, several types of trust vehicles were used to separate a couple's assets so that the surviving spouse did not simply add the deceased spouse's assets to his or her own thus leaving a taxable estate upon his or her death. In 2011, the exclusion became portable, and the survivor of a married couple can now add the unused portion of the deceased spouse's exclusion to his or her own exclusion amount. This is not automatic, however, and it is important to understand that the IRS Form 706 must be filed within 9 months of the decedent's date of death in order to preserve portability. IRS Form 706 must be filed by the Executor or Personal Representative of the decedent's estate.

The "estate" for federal estate tax purposes is different than the "probate estate". The probate estate only includes assets that need to pass through the probate process and does not include assets that pass by beneficiary designation or otherwise pass outside of the probate process. "Estate" for the purposes of determining whether estate tax is due, however, includes nearly everything in the name of the decedent at the time of his or her death, including assets held in a revocable living trust and, under certain circumstance, life insurance. It is also important to remember that the exclusion amount will be reduced by the value of any gifts made during the decedent’s lifetime that exceed the federal annual gift tax exclusion.  This is because the federal estate tax is tied to a federal gift tax which has its own annual exclusion amount.  

The federal estate tax exclusion and the federal gift tax exclusion are interrelated.  A gift tax return must be filed with the IRS by any individual for cumulative gifts to any one person in any year if those gifts exceed the federal annual gift tax exclusion (currently $15,000.00). The amount over the annual gift tax exclusion rate will be deducted from the individual’s federal estate tax exclusion when calculating whether the estate tax is due. Tuition and medical bills that are paid directly to educational institutions or health care providers do not require a gift tax return and will not reduce the available exclusion.

Another aspect of the current federal estate tax rules is the "step-up" (or "step-down") in basis. The basis is the value of an asset used to calculate capital gains. If the sale price of an asset is greater than its basis, then capital gains tax must be paid. The basis of an inherited asset is the value of the asset as of the date of the decedent's death. This is one reason why it pays to be careful about making gifts of assets other than cash, particularly as one ages. Consider a home purchased decades ago for $100,000.00, and now the home is worth $1,000,000.00. That home, gifted during the owner’s lifetime, will retain its tax basis of $100,000.00, whereas the same home inherited after the owner’s death will "step-up" in basis to $1,000,000.00. Bear in mind, however that it is also possible to have a “step-down” in basis if an asset has lost value.  This is a very simplified explanation of the “Step-up” in basis rule, so please be sure to consult a tax professional before making any decisions based on this rule.

Virginia, in addition to not having a separate estate tax, does not currently have an inheritance tax. Many other states do, have either an estate tax (a tax levied on the decedent's assets and payable by the estate), an inheritance tax (a tax levied on a person inheriting assets and paid by that person), or both. If a Virginia resident dies owning real property in another state, some or all of the assets of the estate could be subject to an estate or inheritance tax in the state in which the real property is held.