Estate and gift taxes 2020-2021: Here’s what you need to know

  • By Laura Saunders and Richard Rubin,
  • The Wall Street Journal
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In brief

  • The federal estate- and gift-tax exemption applies to the total of an individual’s taxable gifts made during life and assets left at death.
  • Under current law, investment assets held at death aren’t subject to capital-gains tax. This is known as the “step-up in basis.”
  • For both 2020 and 2021, the annual gift-tax exclusion is $15,000 per donor, per recipient. A giver can give anyone else—such as a relative, friend or even a stranger—up to $15,000 in assets a year, free of federal gift taxes.

The federal estate- and gift-tax exemption applies to the total of an individual’s taxable gifts made during life and assets left at death. In 2017, Congress doubled the exemption starting in 2018, and the amount will continue to rise with inflation through 2025. This expansion reduced the number of taxable estates to about 3,000 in 2019 from about 8,000 in 2017, according to estimates by the Tax Policy Center.

For 2020, the exemption was $11.58 million per individual, or $23.16 million per married couple. For 2021, an inflation adjustment has lifted it to $11.7 million per individual and $23.4 million per couple. For 2020 and 2021, the top estate-tax rate is 40%.

The increase in the exemption is set to lapse after 2025. But the Treasury Department and the IRS issued “grandfather” regulations in 2019 allowing the increased exemption to apply to gifts made while it was in effect if Congress lowers the exemption after those gifts.

Here is a simplified example. Say that John gave assets of $11 million to a trust for his heirs in 2020. This transfer was free of gift tax because the exemption was $11.58 million for 2020.

Now say that in 2022 Congress lowers the exemption to $5 million per person, and John dies in 2023 when that lower exemption is in effect. Under current Treasury rules, John’s estate won’t owe tax on his 2020 gift of $11 million, even if $6 million of it is above the $5 million lifetime limit in effect at the time of his death.

Capital gains at death

Under current law, investment assets held at death aren’t subject to capital-gains tax. This is known as the “step-up in basis.” Some in Congress and the Biden administration want to limit this benefit.

For example, say that Robert dies owning shares of stock worth $100 each that he bought for $5, and he held them in a taxable account rather than a tax-favored retirement plan such as an individual retirement account (IRA).

Because of the step-up provision, Robert’s estate won’t owe capital-gains tax on the $95 of growth in each share of stock. Instead, the shares go into his estate at their full market value of $100 each. Heirs who receive the shares then have a cost of $100 each as a starting point for measuring taxable gain when they sell.

Annual gift-tax exemptions

For both 2020 and 2021, the annual gift-tax exclusion is $15,000 per donor, per recipient. Thus a giver can give anyone else—such as a relative, friend or even a stranger—up to $15,000 in assets a year, free of federal gift taxes. A couple with two married children and six grandchildren could give away a total of $300,000 per year to these 10 relatives, plus $30,000 to as many friends as they want.

Above the annual exclusion, gifts are subtracted from the giver’s lifetime gift- and estate-tax exemption. Annual gifts aren’t deductible for income-tax purposes, and they aren’t income to the recipient.

If the gift isn’t cash, the giver’s “cost basis” carries over to the recipient. So if Aunt Ruth gives her godchild Betty 15 shares of long-held stock worth a total of $15,000 that she acquired for $200 each, then Betty’s starting point for measuring taxable gain when she sells is $200 per share. If she sells a share for $1,200, then her taxable gain would be $1,000.

Gifts to pay tuition or medical expenses are also free of gift tax. To qualify for this break, the giver must make the payment directly to the institution.

Bunching gifts for college

Using a different strategy, givers can “bunch” five years of annual $15,000 gifts to a 529 education-savings plan, typically for children or grandchildren.

No tax is due, but the IRS says a gift tax return should be filed.

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