Chicago Tax Guy: Demystifying Wealth Taxes
With advances in medical science being what they are, the only sure thing in life is that everyone will have to pay taxes. Taxes come in all sorts of shapes, forms and varieties. There is one little understood tax genre broadly known as “wealth” taxes…I think you should know more.
The federal and all of the various local governments around the country like to levy taxes on their citizens. It’s fun for them, and they’ve thought of many different ways of doing just that.
There are sales taxes, income taxes, property taxes, luxury taxes, sin taxes and, of course, wealth taxes. Wealth taxes breakdown into three specific taxes: Gift, Estate, and Generation Skipping Transfer taxes. I’ll “skip” (pun, get it?) talking about the Generation Skipping Tax for another post, and focus on Gift and Estate taxes.
The underlying policy of Gift and Estate taxes is basically two-fold: (1) if you’re wealthy you can pay more tax and (2) lawyers need jobs. The primary concept to remember in this area is that these are taxes on wealth…money and property accumulated (usually over the course of a lifetime) by a person. Although similar, these taxes have different triggers.
Estate Tax
The Estate Tax is imposed by the federal government and almost all of the states. Fear-mongers refer to this tax as the “Death Tax” because it sounds scary and unfair. Basically, at the moment just before a person’s death, he/she has or is deemed to have ownership of certain assets. The value of all of these assets is added up, which figure becomes that person’s Gross Estate. A few deductions later and the Gross Estate becomes the Taxable Estate. Apply tax rate and voila, you have an amount of Estate Tax that must be paid from the person’s assets. Pretty straightforward all in all.
Want an example? Okay. Imagine Joe dies after a long, fulfilling life. At Joe’s death, he had a bank account as his only asset with $10M in it. All other deductions, credits and complicated concepts aside…assume the estate tax rate is 30%. Joe’s family will need to pay an estate tax of $3M. If they don’t, the government will come down hard.
Gift Tax
The Gift Tax is a necessary supplement to the Estate Tax. The Estate Tax, as described above, is basically a tax on wealth at the death of the owner. So death is the triggering event. The tax would be applied even if the owner was buried with all of his money.
The Gift Tax is applied in the case of lifetime transfers, known in legalese as “inter vivos” gifts. So your Grandma gives you a $50 birthday gift…that’s a gift and theoretically if the gift was large enough, the Gift Tax would apply.
A major concept to understand in terms of the Gift Tax is that the person giving the gift pays the tax, not the person receiving the gift. In this respect, the Gift Tax differs from the Income Tax. Again, just to be clear, the person GIVING the gift pays the Gift Tax, not the person RECEIVING the gift.
Why? Well…in part, a Gift Tax is needed to make sure the Estate Tax has any teeth. If people could just give everything away before death, then nobody would have a taxable estate and the Estate Tax would be pointless. The other reason is similar to that of the Estate Tax…if you can give away a bunch of money you can pay some extra tax.
One more example? Okay.
Joe gives his friend Jake a gift of $25,000. If the gift tax rate is 10%, Joe owes the government $2500 in respect of his $25,000 gift to Jake. Joe should learn not to be so generous.
Many, many, many planning opportunities exist with respect to both the Gift and Estate Taxes. I’ll talk about more in later posts.
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