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What Is Estate Tax?

After you die, your estate may have to pay estate taxes at the federal level, state level, or both. Generally speaking, the federal system imposes a tax on property owned by you (or deemed to be owned by you) at the time of your death (gross taxable estate) and certain gifts you made during life (taxable gifts). Hence, the federal system is "unified," taxing gifts and estates.

Estate tax may be one of the largest potential expenses of settling your estate. Prudent planning can reduce this expense and ensure that your property goes to your beneficiaries instead of the federal government. One way to accomplish this is to maximize the use of the exclusions and deductions that are available to you. Understanding what these exclusions and deductions are, and how to use them to your advantage, are the first steps in preparing a plan that works for you.

Tip: This discussion contains information relating to the federal system. Your state may have similar exclusions and deductions. Your should consult an experienced estate planning attorney.

What Is the Annual Gift Tax Exclusion?

One of the easiest ways you can reduce your estate is by making gifts. The annual gift tax exclusion allows you to give $15,000 (in 2019 and 2020) per donee to an unlimited number of donees (persons or organizations you give to) without incurring gift and estate tax. If you give less than the maximum allowed to anyone in a given year, the exclusion is limited to the actual amount of the gift.

Tip: The annual gift tax exclusion is indexed for inflation. The exclusion is currently $15,000, but this amount may change in future years.

This exclusion allows you to:

  • Distribute your property tax free
  • Potentially put your estate into a lower tax bracket

Tip: For gifts made after August 5, 1997, you don't need to file an annual gift tax return with respect to gifts that are within the exclusion unless you have split gifts with your spouse or you have made a partial interest gift to charity (a partial interest gift is split between charitable and noncharitable beneficiaries).

Tip: Gifts you give to your non-U.S. citizen spouse qualify for a $157,000 annual gift tax exclusion in 2020 (up from $155,000 in 2019), but no unlimited marital deduction is allowed.

Tip: The exclusion may also reduce any generation-skipping transfer (GST) tax.

The following requirements must be met to qualify for the exclusion:

The Gift Must Be a Present Interest In Property

A present interest means that the donee (person or organization who receives the gift) has the unrestricted right to the immediate use, possession, or enjoyment of the property or income from the property from the moment the gift is given. The exclusion is not available to gifts of future interests in property.

Technical Note: "Future interests" is a legal term and includes reversions, remainders, and any other delayed interest. Future interest postpones the commencement of the use, possession, or enjoyment of the property or income from the property.

Example(s): Andy gives one of his original paintings to a collector on the condition that he is allowed to keep the painting until his death. The gift is a future interest gift and does not qualify for the exclusion.

A single gift may be part present interest and part future interest. In this case, the exclusion qualifies against the value of the present interest only.

Example(s): Hal sets up a trust and funds it with $100,000. He provides that all the income from the trust is to go to his son Hal, Jr. for a period of 20 years. After 20 years, the remainder of the trust is to go to his daughter Liz.

Example(s): Hal, Jr. has a present interest because he has an immediate right to the income stream for the next 20 years. The value of that right is determined by an actuarial table published by the IRS. The exclusion would apply against this amount. Liz has a future interest because her right to enjoy the capital is delayed for 20 years. The exclusion does not apply to this portion of the gift.

Tip: Gifts to minors (generally, under age 18) can, by their nature, present future interest problems. The IRS provides special methods for qualifying such gifts for the exclusion, including a Section 2503(b) trust, a Section 2503(c) trust, a Crummey trust, or the Uniform Gifts to Minors Act or the Uniform Transfers to Minors Act.

Donee Must Be Identifiable

A gift in trust is considered to be a gift to the beneficiaries of the trust. A gift in trust that gives the trustee discretion over the distribution of income or principal to the beneficiaries does not qualify for the exclusion because it is not possible to identify and value the gift to each beneficiary.

If, however, the trustee does not have such discretion and the identity and value of each gift are determinable, then the exclusion will be allowed for each beneficiary.

The Value of the Gift Must Be Ascertainable

If you can divert gift income from the donee or it is not possible to value the gift at the time it is given, the exclusion will not be allowed.

What Are Split Gifts?

If you are married, a gift made by you to a nonspouse donee may be treated as made half by you and half by your spouse. Gift splitting may be advantageous because it:

  • Doubles the $15,000 annual gift tax exclusion to $30,000
  • Could cause the tax rate to be lower because the tax rate schedule is graduated
  • Allows spouses to effectively use each other's applicable exclusion amount

The requirements for utilizing the gift-splitting privilege are:

  • You and your spouse must be married and U.S. citizens or residents at the time the gift is made
  • You must file a gift tax return and have the consent of your spouse (consent for gift splitting is made on the gift tax return by your spouse's signature)

Caution: Spouses in community property states are eligible to gift-split separate property only. They cannot gift-split community property because the gift is already considered made half by each spouse based on state law.

Tip: Gift splitting is also allowed for GST tax purposes. This allowance makes it easier to use each spouse's GST tax exemption.

Tip: Your personal representative can elect to treat gifts you made prior to your death as split gifts even if you have already reported the gifts as full gifts and paid gift and estate tax. This may reduce any gift and estate tax that may be owed by your estate by reducing your adjusted gross taxable estate by the amount of gifts that are considered half made by your spouse. Your personal representative is given this power because you may not see gift splitting as advantageous at the time you make the gift, but this may be clear to your personal representative when calculating your gift and estate tax.

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What Is the Unlimited Marital Deduction?

If your spouse is a U.S. citizen, the unlimited marital deduction allows you to reduce your gross taxable estate by the value of property you give to your spouse. This deduction, in effect, treats married couples as one economic unit. There is no limit to this deduction. You could conceivably leave your entire estate to your spouse tax free.

Certain requirements and conditions must be met to qualify for the unlimited marital deduction:

  • You must be a U.S. citizen or resident at the time the gift is made.
  • Your spouse must be either a U.S. citizen at the time the gift is made, a citizen before the day on which the estate tax return is due, or a resident of the United States at all times between the date of your death and the date your spouse became a citizen. Otherwise, the property must be transferred to a qualified domestic trust at the time of your death.
  • The recipient of the transfer must be your spouse at the time the transfer is made.
  • The property given to your spouse must be included in your gross taxable estate.
  • The remaining property at your spouse's death must be included in your spouse's gross taxable estate for estate tax purposes.
  • The property given to your spouse must not be a terminable interest (this is the terminable interest rule).

Technical Note: "Terminable interest" is a legal term for a property interest that will end or fail upon the happening of an event or with the passing of a given period of time. This means that the property will be in your spouse's hands only temporarily, and then it will pass to someone else. Life estates, reversions, remainders, annuities, patents, and copyrights are all terminable interests.

Tip: There are exceptions to the terminable interest rule. The most notable exception is qualified terminable interest property (QTIP). The most common example of QTIP is the QTIP trust. A QTIP trust allows you to pass a lifetime income stream to your spouse but name other family members as the ultimate beneficiaries.

Tip: The unlimited marital deduction is also allowed against lifetime gifts to your U.S. citizen spouse for gift tax purposes. This means that your taxable gifts are reduced by the unlimited marital deduction. You need not file an annual gift tax return if all gifts made in a given year fully qualify for the unlimited marital deduction.

Tip: Gifts to spouses can result in many other benefits, such as:

  • Equalizing the size of your estates
  • Creating an estate for the poorer spouse as a hedge against that spouse's earlier death and consequent loss of the unlimited marital deduction to the wealthier spouse
  • Preserving the benefit of the poorer spouse's applicable exclusion amount and GST tax exemption

What Is the Charitable Deduction?

The charitable deduction allows you to deduct the value of all property you give to charity from your gross taxable estate. There is no limit on the amount that you can pass to charity. Giving to charity has many advantages such as allowing you to:

  • Distribute your property tax free
  • Potentially put your net taxable estate into a lower tax bracket
  • Satisfy your personal philanthropic desires

Certain conditions and requirements must be met to qualify for this deduction:

  • You must make the gift yourself, either during life or by will, rather than your personal representative or heirs.
  • The property must be transferred to a qualified charity for a charitable purpose. A qualified charity includes:
  1. The United States, any state, and the District of Columbia
  2. Certain religious, scientific, or charitable organizations
  3. Certain veterans organizations
  4. Certain fraternal organizations
  • An employee stock ownership plan if the transfer is a qualified transfer of qualified employer securities

Caution: Gifts to individuals, no matter how needy or worthy, cannot qualify for the charitable deduction.

Tip: The IRS publishes a list of charitable organizations (the Cumulative List), gifts to which qualify for this deduction. The IRS does not define what a qualifying charitable purpose is but has issued letter rulings that discuss what has been allowed and disallowed.

  • The property transferred must be otherwise includable in your gross taxable estate
  • You must be a U.S. citizen or resident at the time the gift is made
  • Generally, the gift must be a present interest

Gifts of future interests do not qualify for the deduction unless the gift is structured as a partial interest gift. Partial interest gifts (property rights given to both charitable and noncharitable interests, e.g., a trust paying income to a noncharitable beneficiary with the remainder going to the charity) may qualify for the deduction if the donated property is transferred to some form of charitable remainder trust.

Tip: Gifts to charity are also deductible for income tax purposes. However, a limit is imposed on the amount you are allowed to deduct and other adjustments may be required.

Tip: The charitable deduction is also allowed against lifetime gifts to charity for gift tax purposes. This means that taxable gifts you make in a given year are reduced by the amount of gifts you give to charity. For gifts made after August 5, 1997, you don't need to file an annual gift tax return unless you have made other taxable gifts, have split gifts with your spouse, or have made a partial interest gift to charity.

What Is The Applicable Exclusion Amount?

The applicable exclusion amount (the amount that can be sheltered from federal gift tax and estate tax by the unified credit) allows you to pass a certain amount of property free from federal gift and estate tax. To qualify for this exclusion, you must be a U.S. citizen or resident at the time of your death. The applicable exclusion amount is $11,580,000 (in 2020, $11,400,000 in 2019) plus any deceased spousal unused exclusion amount. You must use your applicable exclusion amount against any gift tax you owe on lifetime gifts. Any portion of your applicable exclusion amount that you use during life effectively reduces the amount that will be available at your death.



This material was prepared by Broadridge Investor Communication Solutions, Inc., and does not necessarily represent the views of  The Retirement Group or FSC Financial Corp. This information should not be construed as investment advice. Neither the named Representatives nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information or call 800-900-5867.


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