Estate Tax Basics
your estate is large enough, it will face federal estate taxes before
it is distributed to your heirs. In addition, some states also have
state "death taxes" which have to be paid.
Federal estate tax came into being in 1916 and originally concerned
only the very wealthy. It came about for two reasons. First, it
was anticipated that the U.S. would become involved in World War
I, and wars are expensive. Hence, increased tax revenues would be
necessary. Second, and probably more importantly, there was a prevailing
social opinion that inherited wealth was the greatest social evil.
While everyone admired the "self-made" millionaire, few
people had positive opinions about those who became wealthy through
inheritance from their parents. Over the years, the estate tax and
the associated gift tax were modified a number of times. In 1976
the tax rates were made the same.
all U.S. citizens have a Uniform Tax Credit (UTC). This credit fulfils
the first $196,800 in taxes and allowed an estate with a net value
of $600,000 to pass tax free to the intended heirs. The amount in
excess of the net $600,000 was taxed. All of this changed in 2000
when a new tax law was passed. Under the new law, the UTC increases
each year until 2010 when the estate tax is formally ended. Maybe.
One provision of the law, a "sunset" provision, requires
that the law be voted on a second time in 2010. If this vote fails,
then estate taxes will go back to how they were in 1999. Most estate
planners see this as likely in view of approaching financial needs
of both Social Security and Medi-Care.
a result of this, dual estate planning strategies must be considered.
One strategy is if the law is extended, the other is if the law
is not reconfirmed. Thanks Congress.
the Tax Work: The Net Taxable Estate must be determined. The Gross
Taxable Estate is all that a person owns. From this are subtracted:
of the estate and estate owner
taxes due the year of the owner's death
Expenses" including medical, funeral, and legal costs
A state death tax allowance
Unlimited gifts to IRS-recognized charities
subtracting these the Net Taxable Estate is determined. This number
is indexed to the IRS tax table revealing the Gross Estate Tax.
From the Gross Estate Tax is subtracted the Uniform Tax Credit for
the year of the death of the owner. This yields the tax which is
due. The UTC will change over the next several years as thus:
UTC Actual Tax Credit
are two often overlooked surprises in estate plannng. First, many
estates may be large today, yet be fully sheltered by the UTC. However,
inflation over the years may cause the estate to "grow"
into taxability. If the annual inflation rate is 3%, after 10 years
the estate will have become one-third larger. Second, life insurance
death benefits are fully taxable for estate tax purposes (IRC 2042).
Hence, a large but assumedly untaxable estate may face taxes because
the owners both have large life insurance policies and inflation
has increased the size of the estate. If you are a non-U.S. citizen,
but a legal U.S. resident, you need specialized planning because
you will not have the advantage of a full UTC. For alien residents,
the UTC is much smaller.
size of an estate can also be greatly changed if the estate owners
receive an inheritance, as well.
to do? Congress can be unpredictable, particularly looking many
years ahead. In addition, tax laws are easily changed. An estate
plan should have the maximum of flexibility and should also plan
for the worst case scenario. In other words, despite tax law changes,
assume that the law of 1999 will return and plan for that.