When someone passes away, they leave behind what is known as an estate. The estate represents the culmination of their personal property and depending on a number of factors there will be a tax imposed upon the estate when it is passed or given to another party. The estate tax or gift tax as it is sometimes called only applies to estates that leave behind $5.43 million in value. Anything less than that and the estate is not taxed when it passes from the deceased to another party which is usually the children.
The History of the Estate Tax
The first recorded history of the estate tax in the US occurred in the War Revenue Act of 1898 when it was applied to all distributive shares of personal property that exceeded $10,000. This particular tax was based on succession and did not affect distributions of the land. The duty was scaled at 75 cents per $100 up to $5 per $100 if the legacy was under $25,000. Over that amount resulted in the rate being multiplied 11 times on estates valued at $100,000 and progressively upwards as the value of the estate increased. This law was challenged and upheld in the US Supreme Court.
Over the decades, the estate tax has changed in form many different times in order to adjust to the growing wealth of Americans. For a brief time in 2010, the estate tax itself was abolished. However, today the estate or gift tax is now set at $5.43 million in value which is designed to only affect the very wealthy. However, there is still a movement to abolish the estate tax on general principle since many view it as an unnecessary burden when property is being passed to another generation.
However, as with virtually any tax there are exemptions and deductions that are present which takes away some of the tax burden imposed on those who receive the estate.
Different Types of Exemptions and Deductions
The number of exemptions and deductions will sometimes vary depending on what new tax laws are passed. Plus, there are a number of states that have their own tax penalty or deduction which may apply to the estate.
Personal Estate Tax Exemption: This is an exemption that allows for a particular dollar amount of property to pass without any taxation no matter who is the recipient. For those who passed away in 2014, the amount of the exemption was $5.34 million and in 2015 it was $5.43 million. Since the amount is indexed for inflation, it will most likely increase in the future on a year by year basis. So, for estates that are worth less than the amount exempted which constitutes roughly 99% of all estates, there will be no federal estate tax imposed upon your passing. However, if you have made taxable gifts during your life, then the amount of the personal exemption will be reduced by the amount of the taxable gifts.
Marital Deduction: Property that is left to the surviving spouse is free of all federal estate taxes. This includes same-sex couples who are legally married and recognized in the state where they live. This type of deduction is not valid if the property was left to a non-citizen of the US who is also a spouse. However, the personal estate or gift tax exemption still applies to non-citizens that are also spouses.
Basically, the surviving spouse will get a considerable tax break when being left the estate of the deceased assuming that he or she didn’t use up their individual tax exemption. Assuming this is the case, the survivor can use what is left. That means the couple gets a total exemption that is twice the individual amount which can be split between them in a manner that provide the best tax benefit.
A good example is if one spouse dies and leaves $4 million to their widow, there is no estate tax because the amount is considerably below the $5.43 million. If the widow passes away and leaves behind $6 million which includes the $4 million left to her by the spouse to their children, the estate still will not owe any taxes because the $6 million is still below the combined amount that the first spouse did not use for their exemption which would be $5.43 million plus the $1.43 million from the previous spouse equals $6.86 million in exemptions.
Charity: All the property left to a charity organization that is tax-exempt is also free of any estate tax. This means that a person who wishes to donate part or all of their property to a recognized tax-exempt charity will not have any estate taxes placed on the property that is donated. This is a common tactic of those who are very wealthy who wish to leave part or all of what they own to causes they believe.
Estate Taxes from the State
Depending on where you live, the state may also take a bite in terms of estate or inheritance taxes that may be owed. You will need to review the rules and regulations in terms of your state’s estate or gift tax policies to see exactly where you stand. In most cases, there will be little that you can do short of moving to another state when it comes to getting deductions or having the overall tax reduced.
For those who believe their estate will be large enough to be subject to the federal estate tax, it is best to get advice from an experienced estate planning lawyer so that you can fully review the options. You may find that there are certain planning tools that will reduce the total liability owed for the estate tax. It is best to take steps as soon as possible in order to avoid as many penalties as you can. For those who own estates that are close to the personal exemption, it may pay to sell parts of it so that the total amount remaining will be below the stated exemption. However, keep in mind that it is indexed and the overall amount will go up each year.