Department of the Treasury

Internal Revenue Service

Publication 950

(Rev. September 2006)

Cat. No. 14447X

Introduction

to Estate

and Gift

Taxes

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faster and easier by:

Internet • www.irs.gov
What’s New

The provisions of the Economic Growth and Tax Relief

Reconciliation Act of 2001 made a number of changes to

the estate tax and the gift tax rates and to the applicable

exclusion amounts.

• The top marginal tax rate applicable to estate and

gifts has decreased from 47 percent in 2005 to 46

percent in 2006, and will remain at 45 percent for

2007, 2008, and 2009.

• The estate tax has been repealed for 2010 and the

highest gift tax rate will be decreased to 35 percent

for 2010. The changes to the applicable exclusion

amounts are discussed later in this publication.

• The provisions for these changes are currently set

to expire for estates of decedents dying and gifts

made after December 31, 2010.

Introduction

If you give someone money or property during your life,

you may be subject to federal gift tax. The money and

property you own when you die (your estate) may be

subject to federal estate tax. The purpose of this publication is to give you a general understanding of when these

taxes apply and when they do not. It explains how much

money or property you can give away during your lifetime

or leave to your heirs at your death before any tax will be

owed. Gifts you make during your life or bequests from

your estate can also be subject to an additional tax, the

generation-skipping transfer (GST) tax, if the gifts or

bequests are to a person, such as a grandchild, who is

more than one generation younger than you.

No tax owed. Most gifts are not subject to the gift tax

and most estates are not subject to the estate tax. For

example, there is usually no tax if you make a gift to your

spouse or to a charity or if your estate goes to your

spouse or to a charity at your death. If you make a gift to

someone else, the gift tax does not apply until the value

of the gifts you give that person exceeds the annual

exclusion for the year. See Annual exclusion under Gift

Tax, on page 4.

Even if tax applies to your gifts or your estate, it may

be eliminated by the unified credit, discussed later.

No return needed. Gift tax returns are filed annually.

However, you do not need to file a gift tax return unless

you give someone, other than your spouse, money or

property worth more than the annual exclusion (discussed on page 4) for that year. An estate tax return

generally will not be needed unless the estate is worth

more than the applicable exclusion amount for the year

of death. This amount is shown in the table under Unified

Credit (Applicable Exclusion Amount), on page 4.

No tax on the person receiving your gift or estate.

The person who receives your gift or your estate will not

have to pay any federal gift tax or estate tax because of it.

Page 2 Publication 950 (September 2006)
Also, that person will not have to pay income tax on the

value of the gift or inheritance received.

No income tax deduction. Making a gift or leaving

your estate to your heirs does not ordinarily affect your

federal income tax. You cannot deduct the value of gifts

you make (other than gifts that are deductible charitable

contributions).

What this publication contains. If you are not sure

whether the gift tax or the estate tax applies to your

situation, the rest of this publication may help you. It

explains in general terms:

• When tax is not owed because of the unified credit,

• When the gift tax does and does not apply,

• When the estate tax does and does not apply, and

• When to file a return for the gift tax or the estate

tax.

This publication does not contain any information

about state or local taxes. That information should be

available from your local taxing authority.

Where to find out more. This publication does not

contain all the rules and exceptions for federal estate and

gift taxes. It does not contain the rules that apply to

nonresident aliens. If you need more information, see the

following publication, forms, and instructions:

• Publication 559, Survivors, Executors, and Administrators;

• Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return;

• Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return; and

• Form 706-NA, United States Estate (and Generation-Skipping Transfer) Tax Return, Estate of nonresident, not a citizen of the United States.

To order these forms, call 1-800-TAX-FORMS

(1-800-829-3676). If you have access to TTY/TDD equipment, you can call 1-800-829-4059. To get these forms

using your personal computer, go to www.irs.gov.

Unified Credit (Applicable

Exclusion Amount)

A credit is an amount that eliminates or reduces tax. A

unified credit applies to both the gift tax and the estate

tax. You must subtract the unified credit from any gift tax

that you owe. Any unified credit you use against your gift

tax in one year reduces the amount of credit that you can

use against your gift tax in a later year. The total amount

used during life against your gift tax reduces the credit

available to use against your estate tax.

Publication 950 (September 2006) Page 3
The unified credit against taxable gifts will remain at

$345,800 (exempting $1 million from tax) through 2009,

while the unified credit against estate tax increases during the same period. The following table shows the unified credit and applicable exclusion amount for the

calendar years in which a gift is made or a decedent dies

after 2001.

For Gift Tax For Estate Tax

Purposes: Purposes:

Applicable Applicable

Unified Exclusion Unified Exclusion

Year Credit Amount Credit Amount

2002 and 345,800 1,000,000 345,800 1,000,000 2003

2004 and 345,800 1,000,000 555,800 1,500,000 2005

2006,

2007, and 345,800 1,000,000 780,800 2,000,000

2008

2009 345,800 1,000,000 1,455,800 3,500,000

For examples of how the credit works, see Applying the

Unified Credit to Gift Tax and Applying the Unified Credit

to Estate Tax, later.

Gift Tax

The gift tax applies to the transfer by gift of any property.

You make a gift if you give property (including money), or

the use of or income from property, without expecting to

receive something of at least equal value in return. If you

sell something at less than its full value or if you make an

interest-free or reduced-interest loan, you may be making a gift.

The general rule is that any gift is a taxable gift.

However, there are many exceptions to this rule.

Generally, the following gifts are not taxable gifts:

• Gifts that are not more than the annual exclusion

for the calendar year,

• Tuition or medical expenses you pay directly to a

medical or educational institution for someone,

• Gifts to your spouse,

• Gifts to a political organization for its use, and

• Gifts to charities.

Annual exclusion. A separate annual exclusion applies to each person to whom you make a gift. For 2006,

the annual exclusion is $12,000. Therefore, you generally can give up to $12,000 each to any number of people

in 2006 and none of the gifts will be taxable.

However, gifts of future interests cannot be excluded

under the annual exclusion provisions. A gift of a future

interest is a gift that is limited so that its use, possession,

or enjoyment will begin at some point in the future.

Page 4 Publication 950 (September 2006)
If you are married, both you and your spouse can

separately give up to $12,000 to the same person in 2006

without making a taxable gift. If one of you gives more

than $12,000 to a person in 2006, see Gift Splitting, later.

Inflation adjustment. The annual exclusion may be

increased due to cost-of-living adjustments. See the instructions for Form 709 for the amount of the annual

exclusion for the year you make the gift.

Example 1. In 2006, you give your niece a cash gift

of $8,000. It is your only gift to her this year. The gift is not

a taxable gift because it is not more than the $12,000

annual exclusion.

Example 2. You pay the $15,000 college tuition of

your friend. Because the payment qualifies for the educational exclusion, the gift is not a taxable gift.

Example 3. In 2006, you give $25,000 to your

25-year-old daughter. The first $12,000 of your gift is not

subject to the gift tax because of the annual exclusion.

The remaining $13,000 is a taxable gift. As explained

later under Applying the Unified Credit to Gift Tax, you

may not have to pay the gift tax on the remaining

$13,000. However, you do have to file a gift tax return.

More information. See Form 709 and its instructions

for more information about taxable gifts.

Gift Splitting

If you or your spouse make a gift to a third party, the gift

can be considered as made one-half by you and one-half

by your spouse. This is known as gift splitting. Both of

you must consent (agree) to split the gift. If you do, you

each can take the annual exclusion for your part of the

gift.

In 2006, gift splitting allows married couples to give

up to $24,000 to a person without making a taxable gift.

If you split a gift you made, you must file a gift tax

return to show that you and your spouse agree to use gift

splitting. You must file a Form 709 even if half of the split

gift is less than the annual exclusion.

Example. Harold and his wife, Helen, agree to split

the gifts that they made during 2006. Harold gives his

nephew, George, $21,000, and Helen gives her niece,

Gina, $18,000. Although each gift is more than the annual exclusion ($12,000), by gift splitting they can make

these gifts without making a taxable gift.

Harold’s gift to George is treated as one-half

($10,500) from Harold and one-half ($10,500) from

Helen. Helen’s gift to Gina is also treated as one-half

($9,000) from Helen and one-half ($9,000) from Harold.

In each case, because one-half of the split gift is not more

than the annual exclusion, it is not a taxable gift. However, each of them must file a gift tax return.

Applying the Unified Credit to Gift Tax

After you determine which of your gifts are taxable, you

figure the amount of gift tax on the total taxable gifts and

apply your unified credit for the year.

Publication 950 (September 2006) Page 5
Example. In 2006, you give your niece, Mary, a

cash gift of $8,000. It is your only gift to her this year. You

pay the $15,000 college tuition of your friend, David. You

give your 25-year-old daughter, Lisa, $25,000. You also

give your 27-year-old son, Ken, $25,000. Before 2006,

you had never given a taxable gift. You apply the exceptions to the gift tax and the unified credit as follows:

1. Apply the educational exclusion. Payment of tuition

expenses is not subject to the gift tax. Therefore,

the gift to David is not a taxable gift.

2. Apply the annual exclusion. The first $12,000 you

give someone during 2006 is not a taxable gift.

Therefore, your $8,000 gift to Mary, the first

$12,000 of your gift to Lisa, and the first $12,000 of

your gift to Ken are not taxable gifts.

3. Apply the unified credit. The gift tax on $26,000

($13,000 remaining from your gift to Lisa plus

$13,000 remaining from your gift to Ken) is $5,120.

You subtract the $5,120 from your unified credit of

$345,800 for 2006. The unified credit that you can

use against the gift tax in a later year is $340,680.

You do not have to pay any gift tax for 2006. However,

you do have to file Form 709.

Filing a Gift Tax Return

Generally, you must file a gift tax return on Form 709 if

any of the following apply.

• You gave gifts to at least one person (other than

your spouse) that are more than the annual exclusion for the year.

• You and your spouse are splitting a gift.

• You gave someone (other than your spouse) a gift

of a future interest that he or she cannot actually

possess, enjoy, or receive income from until some

time in the future.

• You gave your spouse an interest in property that

will be ended by some future event.

You do not have to file a gift tax return to report gifts to

(or for the use of) political organizations and gifts made

by paying someone’s tuition or medical expenses.

You also do not need to report the following deductible gifts made to charities:

• Your entire interest in property, if no other interest

has been transferred for less than adequate consideration or for other than a charitable use; or

• A qualified conservation contribution that is a restriction (granted forever) on the use of real property.

More information. If you need to file a gift tax return,

you should see Form 709 and its instructions.

Page 6 Publication 950 (September 2006)
Estate Tax

Estate tax may apply to your taxable estate at your death.

Your taxable estate is your gross estate less allowable

deductions.

Gross Estate

Your gross estate includes the value of all property in

which you had an interest at the time of death. Your gross

estate also will include the following:

• Life insurance proceeds payable to your estate or,

if you owned the policy, to your heirs;

• The value of certain annuities payable to your estate or your heirs; and

• The value of certain property you transferred within

3 years before your death.

Taxable Estate

The allowable deductions used in determining your taxable estate include:

• Funeral expenses paid out of your estate,

• Debts you owed at the time of death,

• The marital deduction (generally, the value of the

property that passes from your estate to your surviving spouse), and

• The charitable deduction (generally, the value of

the property that passes from your estate to the

United States, any state, a political subdivision of a

state, or to a qualifying charity for exclusively charitable purposes).

More information. For more information on what is

included in your gross estate and the allowable deductions, see Form 706 and Form 706-NA and their instructions.

Applying the Unified Credit to Estate Tax

Basically, any unified credit not used to eliminate gift tax

can be used to eliminate or reduce estate tax. However,

to determine the unified credit used against the estate

tax, you must complete Form 706.

Filing an Estate Tax Return

An estate tax return, Form 706, must be filed if the gross

estate, plus any adjusted taxable gifts and specific gift

tax exemption, is more than the filing requirement for the

year of death.

Adjusted taxable gifts is the total of the taxable gifts

you made after 1976 that are not included in your gross

estate. The specific gift tax exemption applies only to

gifts made after September 8, 1976, and before 1977.

Publication 950 (September 2006) Page 7
Filing requirement. The following table lists the filing

requirement for the estate of a decedent dying after

2001.

Filing

Year of Death: Requirement:

2002 and 2003 .............. 1,000,000

2004 and 2005 .............. 1,500,000

2006, 2007, and 2008 ......... 2,000,000

2009 .................... 3,500,000

More information. If you think you will have an estate

on which tax must be paid, or if your estate will have to

file an estate tax return even if no tax will be due, see

Publication 559, Form 706, Form 706-NA, and the forms’

instructions for more information. You can get publications and forms from the IRS website, which is

www.irs.gov. You (or your estate) may want to get a

qualified estate tax professional to help with estate tax

questions.

Generation-Skipping Transfer Tax

The GST tax may apply to gifts or direct skips occurring

at your death to skip persons. The GST tax is calculated

on the value of the gift or bequest, after subtraction of any

allocated GST exemption, at the maximum estate tax

rate for the year involved. Each individual has a GST

exemption equal to the applicable exclusion amount for

the year involved.

A direct skip is a transfer made during your life or

occurring at your death that is:

• Subject to the gift or estate tax,

• Of an interest in property, and

• Made to a skip person.

A skip person is generally a person who is assigned to

a generation that is two or more generations below the

generation assignment of the donor. For instance, your

grandchild will generally be a skip person to you or your

spouse. The GST tax is computed on the amount of the

gift or bequest transferred to a skip person, after subtraction of any GST exemption allocated to the gift or bequest

at the maximum gift and estate tax rates.

More information. If you think you will have a gift or

bequest on which GST tax must be paid, see Form 709,

Form 706, Form 706-NA, and the forms’ instructions for

more information. You can get publications and forms

from the IRS website, which is www.irs.gov. You (or your

estate) may want to get a qualified estate tax professional to help with the generation-skipping transfer tax

questions.

Page 8 Publication 950 (September 2006)