Understanding how taxes affect your estate

Points to know

• The 3 federal taxes you need to be aware of are the estate tax, gift tax, and generation-skipping transfer (GST) tax.
• Depending on the state in which you live, your estate or beneficiaries may also have to pay a state gift tax, estate tax, inheritance tax, or a combination of some or all of them.

Federal estate tax

The federal estate tax may be imposed on the value of your taxable estate, which is the total value of assets remaining in your estate after your exemption amount and any deductions you're eligible for have been subtracted. Assets that pass directly to your U.S. citizen spouse or a qualified charity are also excluded.

What's an exemption amount?

U.S. citizens are entitled to transfer a certain amount of money free of federal estate and gift taxes. In 2023, the exemption amount for U.S. citizens is $12.92  million, adjusted for inflation annually.

This amount is "unified"—it applies to gifts during your lifetime and amounts you bequeath after you're gone.

For example, your estate can use any portion of your exemption amount not used during your lifetime for gift tax exemptions. Conversely, if you've already used up your exemption amount by the time you pass away, your entire estate may be subject to estate tax.

Federal gift tax

The federal gift tax is imposed when you make gifts during your lifetime that total more than the exemption amount.

However, certain gifts don't count against your exemption amount. You can transfer up to $17,000 in 2023 ($34,000 for married couples) to an unlimited number of people each year without incurring gift tax.

In addition, you can give unlimited gifts to your U.S. citizen spouse, contribute to qualified charitable organizations, and pay medical or tuition expenses for any person (as long as your payments are made directly to the medical provider or educational institution).

Generation-skipping transfer tax

The generation-skipping transfer (GST) tax may be due—in addition to the estate or gift tax—when you transfer assets to someone who is 2 or more generations from you. If the beneficiary isn't related to you, the tax may be imposed if that person is more than 37½ years younger than you.

Here are 2 examples of when the GST tax may apply:

• A grandparent makes a direct gift to a grandchild.
• A grandparent sets up a trust for a grandchild while the grandchild's parents are still alive.

Like the estate and gift taxes, the GST tax has an exemption amount ($12.92 million in 2023), so consult with your tax advisor before making gifts to younger generations.