What is the estate tax and who pays? Estate taxes can cut into your legacy. When you die, they're imposed on your net estate value after deductions from your gross estate. Your gross estate is the value of all property in which you have any interest at your death plus items you gifted within 3 years of death.
The estate tax return must be filed within nine months after the decedent's death, although you can file for a six month extension. Valuation of the estate can be made either at the date of death or six months later (sometimes, if for example, stock in the estate have fallen in value, it will be better to value the estate at the later date). Below we look at how estate tax gets calculated.
What property interests are included in your gross estate?
Included is the value of all your property interests such as:
- Any assets that you own individually and outright.
- Half or all Jointly-owned assets:If held with rights of survivorship between husband and wife, then one-half of the value of such joint property is included in the gross estate of the first joint tenant to die and the other one-half is excluded from the gross estate.
- If held with right of survivorship between persons who are not husband and wife (e.g. parent-child or brother-sister), then the entire value of any joint property is included in the estate of the first joint tenant to die, unless the estate can affirmatively prove that the surviving joint tenant supplied some or all of the money used to purchase the joint property. For this and other reasons, it is a bad idea to hold assets jointly with children thinking it will make the estate transition easier.
- Life Insurance proceeds on your life if:
- the policy proceeds are payable directly or indirectly to your estate; or
- you held any incident of ownership in the policy, such as the right to change the beneficiary, surrender or cancel the policy or borrow against the policy. For this reason, you never want to be the owner of your own life insurance policy. In general, it should be owned by the beneficiaries.
- The value of gifts made within 3 years of death since they are considered as given in contemplation of imminent death. Of course this is not logical, but you cannot argue with IRS.
What are the estate tax deductions from your gross estate which help to reduce the estate tax?
You can deduct funeral expenses and expense incurred in administering the estate property for estate tax purposes, net losses during the administration, debts of the decedent, mortgages and liens, and charitable, public, and similar gifts, and lastly, but most significantly - the marital deduction.
The marital deduction includes any bequest to the surviving spouse and is unlimited. But it's allowed only where
- the marital bequest goes to a legally recognized spouse,
- the surviving spouse is a citizen of the United States, and
- the marital bequest is included in the value of the gross estate.
Full use of the marital deduction to eliminate your estate taxes may produce a highly taxed estate at your spouse's death which can then cut into your children's legacy. That is why IRS permits you to leave an unlimited amount to your spouse without taxation as they will eventually get their estate tax when your spouse dies (and more of it for reasons we won't cover in this post). Use a by-pass trust to help eliminate this consequence.
We have many articles on estate planning in this blog so just use the search function for further reading.