Estate and gift taxation is a topic that many CPA exam candidates find intimidating, but it does not have to be. While the rules can seem complex, the CPA exam tends to test a predictable set of concepts. If you understand the unified transfer tax system, know the key exclusions and deductions, and can work through a basic taxable estate or taxable gift calculation, you will be well prepared.
This guide covers the estate and gift tax rules most commonly tested on the REG section, organized to help you build a clear framework for answering exam questions.
The Unified Transfer Tax System
The federal estate tax and gift tax are part of a single, unified transfer tax system. This means that the same tax rate schedule and the same lifetime exemption (unified credit) apply to both lifetime gifts and transfers at death. The purpose of unifying these taxes is to prevent taxpayers from avoiding estate tax by giving away all their assets before death.
The unified credit (also called the applicable exclusion amount) is the total amount a person can transfer during their lifetime and at death without paying federal transfer tax. For the exam, you will typically be given the applicable exemption amount in the question. What matters is understanding how it works: taxable gifts made during life use up part of the unified credit, reducing the amount available to shelter the estate from tax at death.
Gift Tax Fundamentals
A gift occurs when a person transfers property to another person for less than full and adequate consideration. The gift tax is imposed on the donor, not the recipient. Key rules for the exam:
Annual Exclusion
Each donor can give up to the annual exclusion amount per donee per year without incurring any gift tax or using any unified credit. This exclusion applies to gifts of present interests only, not future interests. A present interest is one where the donee has an unrestricted right to the immediate use, possession, or enjoyment of the property.
A married couple can elect gift splitting, which allows them to treat a gift made by one spouse as if each spouse made half the gift. This effectively doubles the annual exclusion for gifts to any single donee.
Gifts Not Subject to Tax
Certain transfers are excluded from the gift tax entirely:
- Tuition: Direct payments to educational institutions for tuition (not room, board, or books) are excluded without limit.
- Medical expenses: Direct payments to medical providers for someone else's medical care are excluded without limit.
- Gifts to a spouse: The unlimited marital deduction applies, so gifts between spouses are not taxable (the recipient spouse must be a U.S. citizen).
- Gifts to charity: Qualify for the charitable deduction.
- Gifts to political organizations.
Taxable Gift Calculation
The formula for computing taxable gifts is:
- Total gifts made during the year
- Minus: annual exclusion for each donee (present interest gifts only)
- Minus: marital deduction for gifts to spouse
- Minus: charitable deduction for gifts to charity
- Equals: taxable gifts for the year
Estate Tax Fundamentals
The estate tax is imposed on the transfer of a deceased person's property. The starting point is the gross estate, which includes all property in which the decedent had an interest at the time of death.
Gross Estate Inclusions
The gross estate includes:
- All property owned by the decedent at death (real estate, bank accounts, investments, personal property)
- Life insurance proceeds on the decedent's life if the decedent owned the policy or had incidents of ownership
- Property over which the decedent held a general power of appointment
- Jointly held property (included based on ownership share or contribution rules)
- Certain transfers made within three years of death (including life insurance policies transferred within three years)
- Revocable trusts and transfers with retained interests
- Annuities and retirement account balances
Taxable Estate Calculation
The formula for computing the taxable estate is:
- Gross estate
- Minus: funeral and administration expenses
- Minus: debts and claims against the estate
- Minus: casualty and theft losses during estate administration
- Minus: marital deduction (property passing to the surviving spouse)
- Minus: charitable deduction (property passing to qualifying charities)
- Minus: state death tax deduction
- Equals: taxable estate
The marital deduction is unlimited, meaning that a decedent can leave any amount to a surviving U.S. citizen spouse without estate tax. This is one of the most powerful estate planning tools and is frequently tested.
Computing the Estate Tax
After determining the taxable estate:
- Add taxable gifts made after 1976 to the taxable estate to get the tentative tax base.
- Compute the tentative tax using the unified rate schedule.
- Subtract gift taxes payable on post-1976 gifts.
- Subtract the unified credit (applicable credit amount).
- The result is the estate tax payable.
Basis Step-Up at Death
One of the most important estate tax concepts, and one of the most frequently tested, is the basis step-up. Under Section 1014, the basis of property acquired from a decedent is generally the fair market value of the property at the date of death (or the alternate valuation date, if elected). This means all unrealized appreciation during the decedent's lifetime is forgiven, it is never subject to income tax.
Key points:
- The step-up applies to the decedent's share of community property and to the decedent's share of jointly held property.
- If the alternate valuation date is elected (six months after death), the stepped-up basis is the FMV on that date.
- The step-up applies whether the property goes to heirs, a surviving spouse, or is distributed from the estate.
- In contrast, gifted property takes a carryover basis (the donor's basis), with a special rule for losses if FMV at the date of gift was less than the donor's basis.
Generation-Skipping Transfer Tax
The generation-skipping transfer (GST) tax is an additional tax imposed on transfers that skip a generation, such as a grandparent leaving property directly to a grandchild. The purpose is to prevent wealthy families from avoiding one layer of estate tax by skipping the middle generation.
The GST tax applies at the highest estate tax rate and has its own exemption amount (equal to the estate tax exemption). The three types of generation-skipping transfers are direct skips, taxable distributions, and taxable terminations. The CPA exam typically tests basic awareness of the GST tax rather than detailed calculations.
Exam Weight and Focus Areas
Estate and gift tax typically represents a small but reliable portion of the REG exam. The areas most likely to be tested include:
- Computing taxable gifts (including annual exclusion and marital deduction)
- Identifying what is included in the gross estate
- Computing the taxable estate
- Understanding the unified credit and how it connects gifts to estate tax
- Basis step-up versus carryover basis for gifted property
- The unlimited marital deduction
Study Tips
Focus your study time on the mechanical calculations. Practice computing taxable gifts and taxable estates from a set of facts. Know which exclusions and deductions apply. Understand the difference between the annual exclusion (gift tax only) and the unified credit (applies to both gift and estate tax). And always remember the distinction between stepped-up basis at death and carryover basis for gifts.
Think CPA's REG materials include targeted estate and gift tax questions that mirror what you will see on the actual exam. The key is practicing until the calculations feel automatic, because on exam day, you want to spend your mental energy on the tricky parts, not the mechanics.
Estate and gift tax may not dominate the REG section, but the questions that do appear are very scoreable if you have prepared. Do not skip this topic; learn the fundamentals and pick up the easy points.