There are two major types of "transfer taxes", that is taxes on the transfer of wealth, that might apply when someone dies. Generally speaking, the same taxes are applicable whether or not there is a will.

The first transfer tax is called the "federal estate tax", which is a tax paid according to the net value of the decedent's "estate." The decedent's estate consists of all property, regardless of type, in which the decedent held any interest at the time of death. The estate will include jointly held property, insurance proceeds on the decedent's life, real estate, personal property, cash, business interests, etc. the value of the assets on the date of the decedent's death is generally the value that controls the amount of tax paid by the decedent's estate.

The federal estate tax will have to be paid only if the net value of the estate, after allowance for certain deductions such as funeral expenses and debts, exceeds $600,000. This large exemption has been phased in over the last several years and, as a result, many estates pass free of federal estate taxes.

One very favorable change to the federal estate tax law has been the advent of the unlimited "marital deduction" for property passing to the surviving spouse. In other words, if the decedent's estate passes to the decedent's surviving spouse, the estate is allowed a 100% deduction, and this marital deduction is in addition to the $600,000 exemption discussed above. If the surviving spouse receives all of the deceased spouse's property, there will be no tax on the first death because of the marital deduction. However, there will be an estate tax on the second death if the estate is still worth more than $600,000.

The unlimited marital deduction can cause unsuspecting couples to pay unnecessary estate taxes. The $600,000 exemption applies to each person and, therefore, if all property is passed to the surviving spouse under the marital deduction, the first spouse's exemption is wasted. To the extent a husband and wife have a combined estate in excess of $600,000, careful estate planning can take advantage of both exemptions and significantly reduce or even eliminate the imposition of death taxes.

The second transfer tax is one imposed by the state of Tennessee, called the "Tennessee inheritance tax". In many respects, the Tennessee inheritance tax is similar to the federal estate tax discussed earlier. Tennessee also allows the $600,000 personal exemption and the unlimited marital deduction for property passing between spouses.

What happens if you try to avoid the death taxes by giving away all of your property before you die? Another tax is the "gift tax" which is imposed on the transfer of property during life. Just like with the estate tax, there is a federal and state gift tax. However, the gift tax is not imposed on small gifts, so long as the amount given to any one person during any one year does not exceed an amount known as the "annual exclusion."

For federal gift tax purposes, an individual may give up to $10,000 to as many persons as he or she desires each year without paying any federal gift tax. A husband and wife may agree to "split gifts" and make gifts of $20,000 to as many individuals as they desire during each year.

For purposes of the Tennessee gift tax, there is a distinction in rates imposed according to the "class" into which the intended beneficiary falls. "Class A" beneficiaries includes spouses, sons, daughters, lineal ancestors and descendants, brothers, sisters, step-children, and sons and daughters-in-law. Class A beneficiaries enjoy lower rates of tax that "class B" beneficiaries which includes aunts, uncles, nieces, nephews, more distant relatives and non-relatives. In Tennessee, the $10,000 (or $20,000 "split gift") exclusion exists only for gifts to class A beneficiaries. The exclusion for class B beneficiaries is only $3,000 per person, per year.

It is important to keep in mind that, to the extent gifts to a person exceed the amounts discussed above, there will be a gift tax imposed. Thus, transfers made during life must be examined to determine the gift tax impact.

Again, just as with the estate tax, proper planning in order to maximize the benefit of the annual exclusion can reduce or eliminate the payment of gift tax.

Another tax which should not be forgotten is the federal generation-skipping tax. The federal generation-skipping tax is a harsh, flat-rate tax of 55% (or the highest federal estate tax rate in effect at the time) imposed upon transfers during life or at death to individuals who are two or more generation levels below that of the transferor. The most common situation is when property is passed to grandchildren. However, since there is a $1,000,000 exemption available to each transferor, the generation-skipping tax will only apply to estates worth more than $1,000,000. Proper planning with an attorney who is experienced in estate planning will reduce or eliminate the generation-skipping tax in most instances.

The transfer tax laws just described point out the need for proper tax and estate planning to pass the maximum amount of your estate to the intended beneficiaries and to reduce the burden of these taxes, both during life and at death.

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The information available through TBALink LawBytes is basic legal information and is not a substitute for legal advice. LawBytes is provided by the Tennessee Bar Association as a public service and for general information only. It should not be considered legal advice. You should consult your attorney if you have questions concerning any specific situation. If you do not have an attorney, may we suggest that you contact your local bar association's referral service. The topics covered through TBALink LawBytes will provide basic information and should make it easier for someone with a problem to decide whether they need professional help from a lawyer or if another agency could provide them with assistance.