Calculating Gift & Estate Tax: How-To & Example

Instructor: Noel Ransom

Noel has taught college Accounting and a host of other related topics and has a dual Master's Degree in Accounting/Finance. She is currently working on her Doctoral Degree.

This lesson focuses on the definitions of estate and gift taxes and lifetime limits. The lesson also includes examples of how each applies to individuals subject to gift and estate tax rules.

Gift Tax

The gift tax is a tax on assets (property or money) that is transferred or given to another person. The gift tax applies even if the transfer of assets is not an actual gift. For 2015 and 2016, the gift tax exclusion amount is $14,000, which means a person can give another person money or property worth up to $14,000 without being subject to a gift tax.

Examples of Gift Taxation

Here's how the gift tax works. Ronald wins the lottery and receives $100,000 after taxes. Ronald decides to give his only brother $50,000 of his winnings. Ronald is an awesome brother! However, Ronald was not aware that he would be taxed on part of the amount he gave to his brother. Remember: the gift tax exclusion is $14,000, which means Ronald can give his brother $14,000 or less without being subject to the gift tax.

However, because Ronald is an awesome brother, he gives $50,000. Therefore, Ronald (as the gifter, or donor, of the money) must pay tax on $36,000 ($50,000 - $14,000 = $36,000). The donor is subject to the tax, not the recipient of the gift. However, if the donor does not pay the tax, the IRS may ask the recipient to pay the tax.

Thankfully, Ronald does not have to pay the tax immediately, as the gift tax is tied to estate tax rules. Therefore, as long as Ronald does not gift more than $5.45 million during his lifetime, Ronald will not pay gift tax on the $36,000. The gift tax rate is 40% once the donor reaches a lifetime aggregate limit of $5.45 million. The gift tax also applies to gifts of property and assets in addition to gifts of money.

Let's look at another example. Stephanie has three children. Last year, Stephanie gave each of her children $14,000 each as a Christmas gift, which totals $42,000. Stephanie is still not subject to the gift tax because the IRS rules state a person can gift more than one person up to $14,000 each year.

Let's review one last example of a gift. Adam is the owner of a major corporation. Each year for the last five years, Adam has given his mother $1 million. The $1 million is far greater than the $14,000 gift tax exclusion. The IRS takes notice of Adam's gifts and begins to take a tally each year of how much Adam gives to his mother. At year five, Adam has gifted a total of $5 million to his mother.

The lifetime exclusion before any gift tax is $5.45 million. Therefore, Adam can only give his mother $450,000 next year before the gift tax takes effect. Let's say Adam gives his mother another $1 million the very next year. The IRS will calculate the amount of tax Adam must pay. Adam must pay taxes on $550,000 ($1 million - $450,000 = $550,000). The tax rate for gift taxes is tied to the estate tax rate, which is 40%. This means Adam must pay taxes of $220,000 ($550,000 x .40).

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