When it comes to planning a substantial transfer of assets, it may be helpful to have a better understanding of the fundamentals of federal gift and estate tax. In fact, this knowledge may help you feel more confident about how you address your obligations.

For starters, did you know there’s a federal cap on annual and lifetime gift amounts that can change over time? That’s something to keep in mind as you work with a tax attorney, accountant or CPA to address your annual federal income tax filing.

For the purposes of this article, however, we’re going to focus primarily on the role estate tax plays as you prepare to transfer assets to your heirs.

Many of us have good intentions, including a list of things we want to get done prior to passing. We plan on reaching out to family members, getting our accounting records together, living long enough for Medicare to replace our expensive health insurance, organizing our financial affairs, and creating an estate plan strategy. We envision ourselves living long enough to enjoy spending time with our children and grandchildren. Sadly, far too many of us know friends and loved ones who didn't get to meet all of those goals.

When we pass away, we often leave behind possessions or unfinished business: money, property, belongings and even debt. What is left behind is called an estate. Estates and estate taxes are not popular topics of conversation, and for most, there is never a convenient time to put your affairs in order. But it's important to work on those things now to help you understand how taxes may affect your assets and impact your family after your death.

Alas, estate taxes could be one of the largest expenses your estate may pay. It also means that, without careful planning, a significant part of your estate could go to Uncle Sam and not to your loved ones. If your estate planning goals include reducing your tax obligation and preserving much of your estate for your heirs or beneficiaries, you may find it helpful to understand how the federal estate tax system works, how to estimate your potential tax liability and what techniques are available to manage it.

Foundations of the federal gift and estate tax system

The gift tax system and the estate tax system¹ are often considered together. Under the Unified Tax Rate Schedule, lifetime gifts and at-death property transfers are taxed using the same rates. Generally, taxable gifts are reported — and any gift tax owed is paid — annually.

Upon death, all gifts are added to your gross taxable estate for estate tax calculation purposes, even though a gift tax return may already be filed and the gift tax already paid. Then, the gift tax already paid is deducted from any estate tax owed. There is also a basic exclusion amount that can be applied to lifetime gifts and at-death property transfers.

Utilizing the estate tax freeze

Understanding how the unified tax system works and using the system to your benefit can help save your property for your beneficiaries and reduce your potential estate tax liability.

One method you can use to accomplish those goals is the estate freeze. As the name implies, an estate freeze fixes the value of your estate at its federal value on the date of transfer. The strategy involves the transfer of an asset (through a variety of methods) to your beneficiaries with the main goal of removing any future appreciation of that asset from your gross estate and thus potentially reducing any estate taxes that may be due. This could help manage estate taxes because no future growth of your assets will be included in your estate at death. The future appreciation will be attributed to your beneficiaries.

Consult your tax professional before structuring any estate freeze strategy so you don't run afoul of any regulations. Depending on the strategy used, the transfer may trigger capital gains tax or generation-skipping transfer tax (GSTT). Plus, gift tax liability and rules can change.

Why it’s important to estimate estate taxes

There are several potential benefits to arriving at a good estimate on your federal estate taxes. Doing so may help you:

• Save your property for your heirs or beneficiaries. 
• Plan how you'll accommodate payment of the estate tax bill and related expenses.
• Find potential ways to reduce tax liability.

Although estimating federal estate taxes can be complex, keep in mind that the actions you take today might alleviate stress later, particularly for your beneficiaries. The peace of mind that comes with implementing a successful master estate plan strategy should be worth your time and trouble.

The takeaway

When planning your estate strategy, it's important to know and understand federal gift and estate tax rules as well as basic, tax-savvy ways of transferring your assets. Although a tax professional (e.g., attorney, CPA or accountant) will be your primary resource on these matters, please remember that a financial advisor who understands how your estate plan fits into your overall financial plan can be useful, too.