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What is the “Death Tax”?

Oct 04

I was asked recently to write an article on the current status of what is commonly known as the “death tax.” “Death taxes” are legally and more formally known as “estate taxes.”  Estate taxation is extremely complicated and intricate, and this article is meant to only give a brief overview of the subject. In fact, many lawyers specialize in this area, and have received degrees above and beyond law school in order to understand and maneuver around estate taxes. Estate taxes are imposed on the transfer of a person’s “taxable estate” at that person’s death. This transfer of assets can be through a will or according to the state laws regarding transfer of property if there is no will. The estate tax is one part of the “Unified Gift and Estate Tax” system in the United States. The other part of the system, the “gift tax,” imposes a tax on transfers of property during a person’s life.

Estate taxes are governed by federal law, which means congress is in control of how much tax an heir pays on his or her inheritance. Estate tax law is always changing because there is always a huge debate in congress over when, if, and how estate taxes should be paid. Officially, federal estate taxes are imposed on the transfer of the “taxable estate” of every deceased person who is a citizen or resident of the United States. The starting point in calculating a deceased person’s taxable estate is determining the amount of their total estate and subtracting certain allowable federal deductions.

No matter what a person’s taxable estate, however, under current law it has to reach a certain amount before a tax can be imposed – this amount is called the maximum allowable credit. For example, in 2006, the maximum allowable credit was $2 million. So, if a person died in 2006 with a taxable estate of $3.5 million that person’s heirs would not pay estate tax on the first $2 million, but would pay tax on $1.5 million.  

The maximum allowable credit is always a point of controversy in congress, and traditionally it changes from year to year in some way. The number, however, is usually high enough to where most of us will never have to worry about paying estate taxes. For example, from 2006 to 2008, the maximum allowable credit was $2 million. In 2009, it jumped to 3.5 million, and after much congressional debate and controversy it is now $5 million at least until the end of 2012.

What happens at the end of 2012? No one knows. The subject will certainly be debated again, but there is no way to predict the outcome. My advice is not to let any of your heirs near your life-support plug on December 31, 2012 if congress has not come up with a new plan. For now, however, if someone was to pass away on or before December 31, 2012 and their taxable estate was less than $5 million, their heirs would not have to pay any federal estate tax.

For more detailed information regarding estate taxes, you should always see both your lawyer and accountant.