Estate Tax Q and A for Family Caregivers

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When a person dies, control of the property and assets in their estate will be bestowed on either an executor outlined by their will or (in the absence of a will) a court-appointed administrator.

Gross Estate and Taxable Estate

When calculating the amount of tax owed on a decedent's estate, it's important to understand the difference between the "gross estate" and the "taxable estate."

The gross estate is the fair market value of all property that a person owned or had an interest in when they died, including:

  • Money in checking and savings accounts, CDs, and money markets
  • Investment accounts
  • Stocks and bonds in certificate form
  • Personal property (e.g. jewelry, art work, clothing, books, furniture, etc.)
  • Automobiles, airplanes and boats
  • U.S. savings bonds
  • Real estate
  • Closely held business interests (e.g. LLCs, sole proprietorships, partnerships, stock in corporations)
  • Retirement accounts (e.g. annuities; Simple, SEP, Roth and Traditional IRAs; 401(k)s; 403(b)s)
  • Life insurance (If the decedent owns their own policy, then all of the proceeds are included. If the decedent owns a policy on someone else's life, only the cash value of the policy is included.)
  • Life insurance owned by the deceased and transferred into an Irrevocable Life Insurance Trust within three years of their death.
  • Gifts made that exceed the annual gift tax exclusion amount for that year ($14,000 in 2015)
  • Money owed to the deceased (e.g. wages, bonuses and commissions; mortgages and personal loans held by the deceased)

The "taxable estate" is what's left over after all of the applicable deductions are subtracted from the value of the gross estate.

Deductions that can reduce the taxable amount of an estate include: marital deduction (any property that passes to a surviving spouse can be deducted), mortgage and debt amounts, charitable deductions (money and assets given to a qualifying charity), and expenses and losses of administering an estate.

Estate taxes are imposed on the entire taxable estate amount, not the amount allotted to specific beneficiaries, and these taxes must be paid before the decedent's assets and property are disbursed to individual beneficiaries.

When does an estate tax return have to be filed, and who is responsible for paying?

The top federal estate tax rate is 40 percent, as of 2015. If the estate is large enough (a gross estate amount greater than $5,430,000 for 2015), then the executor or administrator will be responsible for calculating the relevant estate taxes and filing a Form 706: United States Estate (and Generation-Skipping Transfer) Tax Return.

It's important to note a few things about estate taxes.

Number one, not all estates will be subject to taxation. Only .14 percent of estates qualified for taxation in 2014, according to the Tax Policy Center.

Number two, under the unlimited marital deduction, property left to a surviving spouse is always tax-exempt, regardless of the amount.

Certain states may also tax an estate, even if it doesn't meet the $5.43 million threshold set for the federal estate tax. Connecticut, Delaware, the District of Columbia, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New Jersey, New York, Oregon, Rhode Island, Vermont and Washington all have an estate tax.

Six states—Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania—have an additional "inheritance tax" that applies to the beneficiaries of an estate. As a general rule, spouses are exempt from the inheritance tax, which ranges between one and 20 percent of the assets an heir receives, depending on their relationship to the deceased (the more closely related, the lower the tax amount). An inheritance tax is paid by the heir on their personal income tax return.

What is "probate" and why is it important?

Probate is the term used to describe the formal legal process that dispenses a decedent's property to his or her heirs. This includes a variety of proceedings—creating a will, designating an executor or administrator for that will, filing taxes, allocating assets and property, and filing a final account for the deceased.

For tax purposes, the term "probate assets" refers to property that is solely owned by the decedent and must be distributed by the court (e.g. bank accounts, real estate, personal property, life insurance policies that identify the decedent or their estate as the beneficiary, etc.).

"Non-probate assets" are those that can be given directly to a person's heirs, thereby skipping the court process (e.g. property held in trust, retirement accounts, life insurance policies where the decedent is not the beneficiary, jointly-held property and bank accounts, assets designated as "payable on death," etc.).

The distinction between these two types of assets is especially important when it comes time to calculate taxes on an estate. Both probate and non-probate assets are included in an individual's gross estate calculations, but to varying degrees.

The legal process of probate is complex and very individualized. Consulting with an elder law attorney who specializes in estate planning is highly-recommended. Learn more about probate: Estate Administration: What to Do When a Loved One Dies.

What are some important things spouses should know about estate taxes?

As mentioned above, any property bequeathed to a surviving spouse is always free from estate tax.

Another important factor for couples to consider is the portable estate tax exemption. This allows the decedent to give whatever portion of their individual federal estate tax exemption amount—$5,430,000 in 2015—to their spouse. In theory, this would enable the surviving husband or wife to claim an exemption of up to $10,860,000 on their estate taxes, if the deceased spouse didn't claim their exemption. The simplest way for couples to take advantage of this rule is by leaving their entire estates to each other, thus negating the need for the first spouse who dies to claim any exemption on their estate taxes.

Of course, other considerations must be taken into account.

For instance, if the surviving spouse remarries and is predeceased by their new partner, then the exclusion amount that the surviving spouse will be able to take advantage of will be limited to whichever is less: $5,430,000 or the portion of their most recent partner's unused exclusion.

What is the generation-skipping transfer tax?

The federal generation-skipping transfer (GST) tax was created as a way to stop people from dodging estate taxes by leaving their assets to a grandchild or other heir (called a "skip person") who is at least two generations below them (or 37.5 years younger).

A GST of up to 40 percent can be applied to assets transfers in excess of $5,430,000 that are either gifted while the "transferor" is still alive, or inherited upon their death. States with estate taxes typically also have additional GST taxes.

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2 Comments

I live in one of the states that has a state inheritance tax. This article states that this tax is paid by the heir on their personal tax return, and has a link to the irs website. Since this is a state (actually collected by the county in my state) tax, it has nothing to do with the federal tax system. Also, even though an heir might live in a state that does not have an inheritance tax, the tax is still owed to the decedent's county. In other words, taxability is dependent on the decedent's residence, not the beneficiary's state of residence. In my state, there are graduated tax rates depending on the relationship of the heir to the decedent, and varying exempt amounts, also dependent on the relationship. This is all reported on a form that is not part of the state income tax return.
When do you 'not' have to go through probate?