This article was last updated on December 3
[Update] – As part of the 2018 Trump tax reform package there is a big push to get the Estate tax fully repealed or raise existing exemption levels. Provisions around this are being debated in Congress and you can get the latest updates in this article.
A change to the estate tax exemption was recently passed into law as part of the Bush-era tax cuts extension. The taxable estate exemption thresholds will be $5 million (from $3.5 million in 2009) for an individual or $10 million for a couple for both estate and gift-tax levies, with a top tax rate of 35% for estates above these levels. These extensions are only for 2 years and will expire at the end of 2012. If Congress had failed to act before the end of the calendar year, the estate tax would have come roaring back in 2011, jolting those who lost a wealthy loved one. While the estate tax may only seem applicable to the super wealthy, you may be surprised to learn that it applies to more people than one may think.
The estate tax is often called the death tax because it imposes a tax on a person’s estate once they pass away. The estate tax dates back almost three thousand years. As early as 700 B.C., there was a 10 percent tax on the transfer of property at death in Egypt.
Looking ahead to the United States, the tradition of taxing assets at death began with the Stamp Act of 1797. The Stamp Act required a federal stamp on all wills which, as you can imagine, came with a hefty price tag. The Stamp Act was nothing more than a way to pay the expenses of the Revolutionary War.
Estate planning in today’s world though is much more complex and just writing a will will not suffice. It now includes organizing your assets in a tax effective way that reduce taxes due on death and to also help avoid family fights.
The modern estate tax debacle dates back to 2001 when Congress voted to gradually raise the estate tax exemption while cutting income tax rates. Congress has continued to debate this contentious tax with Republicans supporting it using the argument that why should wealthy Americans, who shoulder most of the tax burden, be taxed twice for assets/money they own. Democrats and the administration on the other hand argued that the cost to tax payers from extending the exemption levels was too high and only less than 1% of Americans benefit from estate tax provisions.
If the estate tax was reinstated in its pre-Bush Tax Cut levels, rates return with a vengeance of 55% on estates worth $1 million to $10 million and 60% on estates worth more than that. Of course there will be many who won’t have estates that reach the minimum amount but between IRAs, 401(k)s, real estate, and other assets, $1 million isn’t difficult to reach.
With the extension and raising of the estate tax exemption (under a Obama-Republican compromise deal to get other tax extensions approved) many families can now transfer significant amounts to heirs without paying taxes. However the rules around which assets can be transferred tax free and how to account for capital gains can get quite complex, which makes consulting a tax professional a must (after all you can probably afford it!)
(Extension Recap) For 2011 and 2012, estates worth $5 million or less won’t be taxed at all. For estate values greater than that, a 35 percent tax rate will apply.
That’s better than the 2009 law, which imposed a $3.5 million exemption and a 45 percent tax rate on the excess. And it’s much better than what would have happened had the Bush tax cuts expired. If that had happened, estates worth more than $1 million would have faced a 55 tax rate.
The bad news, though, is that Congress has set up a repeat of 2010 in 2013. Unless it acts again, the original $1 million/55 percent rate law will be back.
The head of the American Bar Association’s section that focuses on estate law estimates that less than one-half of 1 percent of people who die in 2011 will be hit by the estate tax. That’s minuscule compared to the 10.5 percent of estates that paid Uncle Sam in 1977.
Options for Claiming the Estate Tax in 2010 Returns: Under the estate tax wording in the bill, the heirs of people who died this year will have two options for a tax bill. If they chose to treat the estate by the tax laws in place in 2010, they will have to calculate the capital gains on all assets in the estate to determine if the value is above a level the IRS is allowing. This “artificial step-up in basis” is $1.3 million to any heir and $3 million to a surviving spouse.
The other option is to apply the 2011 law, which would exempt the first $5 million of the estate and impose a rate of 35 percent on anything above that. This is far more generous than the 2009 law — a $3.5 million exemption and a 45 percent tax rate — which many people thought would be reinstated.