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The Federal Estate Tax How does the federal estate tax work? The answer is, very efficiently. It begins at 41 percent and increases to a maximum of 45 percent. The federal estate tax has two distinct features: First, it can be described as an "everything tax." Yes, Uncle Sam taxes everything, including the proverbial kitchen sink. Second, the federal estate tax is a "top tax." Uncle Sam receives his share before your beneficiaries receive anything. The federal estate tax is not a tax levied against a deceased person or his or her property. It is not a people or property tax at all. It is a tax levied against the "right to transfer" property on death. The federal estate tax is a mystery to many people. For example, many people believe that the death benefit proceeds of life insurance are not includable in an estate for federal estate tax purposes. That's not true. If you own the policy or if you have control over the policy, it is included in your estate for federal estate tax purposes. In fact, everything you own or control at the time of your death must be reported on your estate tax return. Certain deductions are allowed for certain expenses and debts, and special other credits may be available to offset the tax. For example, there is a gift tax credit of $345,800. This is a credit against federal gift tax due. It is the equivalent of exempting about $1,000,000 from a gift tax. When you read or hear that everyone can pass $1,000,000 free from federal gift tax, it is this dollar equivalent of the gift tax credit that is being discussed. There is a federal estate tax credit that is $780,800. In other words, the first $2,000,000 of your assets can be transferred at death without federal estate being due. This is the credit through 2008. In 2009, the credit will be 1,455,800, which means that up to $3,500,000 can be passed to the next generation estate tax free. Charitable gifts can be deducted from the value of an estate to determine whether it is taxable or not. And all the money and property that is left to a surviving spouse is deductible. There is no limit as to how much can be left to a spouse, and that is why this spousal deduction is called the unlimited marital deduction. However, when the surviving spouse dies, if he or she has not remarried and does not leave property to his or her new spouse, then all the surviving spouse's property, after deductions, is subject to federal estate tax. The spouse, who is second to die, does get to use his or her $1,000,000 exemption equivalent as long as it has not been used during the spouse's lifetime through taxable gifts. Once all the appropriate deductions, exemptions, and credits are used, the federal estate tax kicks in. And when it does, the tax bill can be very expensive! What are the federal estate and gift tax rates? Before the new tax law, the federal estate and gift tax rates were unified under the Internal Revenue Code. Starting in 2002, the gift tax credit will be $220,550 or the equivalent of $1,000,000 in assets and remain at that amount, but the estate tax credit will increase as explained above. The interplay between the estate and gift taxes can be explained as follows: the rates for a gift and for estate transfers are the same and that any lifetime gifts are cumulated at the time of your death to push your estate into the highest-possible tax brackets. Whether you give assets away during your life or give them away at death is of no consequence as far as the federal estate or gift tax is concerned. The federal estate or gift tax is applied to the amount of the taxable transfer. After the tax is determined, the unified credit amount is then applied. Every person may take a credit against his or her federal estate or gift tax of $345,800. This credit is the equivalent of $1,000,000 of assets. There is a phaseout of the unified credit for very large estates. Who pays the federal estate tax? Under the present law, only about 2 to 3 million Americans overall have enough wealth accumulated to be concerned about the transfer tax payment. If a husband and wife have more than $4,000,000 in net assets at the death of the first spouse to die, then anything over $2,000,000 at the death of the second spouse to die will be subject to the estate tax, unless tax planning has been incorporated into the estate plan. The 2001 tax act increased the individual credit to $780,800, which is the equivalent of $2,00,000 in assets in 2007 and 2008, and the credit increases in stages to an amount equivalent to $3,500,000 in assets in 2009. In 2010, the estate tax is eliminated for that calendar year, but in 2011, the credit returns to the equivalent of $1,000,000. To say that this is a full explanation of the changes to the estate and gift tax laws is incorrect. There are many other tax and planning issues to be concerned about in the wealth transfer sections of the tax code beyond the scope of this overview, such as the year 2010 elimination of the step-up in basis at death, which could result in the collection of capital gain taxes when currently the cost basis is stepped-up to the date of death value (or a value determined on an alternative valuation date after death). Attendance at a tax planning workshop is recommended for further explanation of these complex issues under the new tax law. (See our workshop schedule for dates, times, and place of our upcoming workshops.) Which assets are included in my estate for purposes of the federal estate tax? Your gross estate will include the following:
The following items are then deducted from your gross estate:
Are loans to family members taxable in a decedent's estate? Yes. Loans to family members are like any other type of loan. They are assets (receivables) included in a decedent's gross estate and subject to federal estate taxes. Even if the decedent's will or trust forgives these loans at death, these loans are nonetheless included as assets in the decedent's estate. A person is considered a nonresident alien if he or she is not a citizen or resident of the United States. For estate tax purposes, a nonresident alien is taxed on all assets situated in the United States, but not on assets held in other countries. If a spouse is a foreign national, then to avoid immediate taxation on the non-U.S. citizen, a qualified domestic trust must be arranged by the decedent's last will or Living Trust. IRS CIRCULAR 230 DISCLOSURE: To ensure compliance with requirements imposed by the IRS, we inform you that, unless expressly stated otherwise, if any U.S. federal tax advice contained in this communication, (including any attachments) is not intended or written to be relied upon or used, and cannot be relied upon or used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction of matter addressed herein. | ||||
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| ©2010, Dallas W. Jolley, Attorney & Counselor at Law. Send questions or comments to info@jolleylaw.com. | |||||
