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The Federal Estate Tax
The Internal Revenue Code imposes a tax on the transfer of the taxable estate of a decedent who is a citizen or resident of the United States. The taxable estate is determined by deducting from the value of the decedent’s gross estate any deductions provided for in the Code. After applying tax rates to determine a tentative amount of estate tax, certain credits are subtracted to determine estate tax liability.
A decedent’s gross estate includes, to the extent provided for in other sections of the Code, the date-of-death value of all of a decedent’s property, real or personal, tangible or intangible, wherever situated. In general, the value of property for this purpose is the fair market value of the property as of the date of the decedent’s death, although an executor may elect to value certain property as of the date that is six months after the decedent’s death (the alternate valuation date).
The gross estate includes not only property directly owned by the decedent, but also other property in which the decedent had a beneficial interest at the time of his or her death. The gross estate also includes certain transfers made by the decedent prior to his or her death, including: (1) certain gifts made within three years prior to the decedent’s death; (2) certain transfers of property in which the decedent retained a life estate; (3) certain transfers taking effect at death; and (4) revocable transfers. In addition, the gross estate also includes property with respect to which the decedent had, at the time of death, a general power of appointment (generally, the right to determine who will have beneficial ownership). The value of a life insurance policy on the decedent’s life is included in the gross estate if the proceeds are payable to the decedent’s estate or the decedent had incidents of ownership with respect to the policy at the time of his or her death.
Deductions from the Gross Estate
A decedent’s taxable estate is determined by subtracting from the value of the gross estate any deductions provided for in the Code.
Marital and charitable transfers: Transfers to a surviving spouse or to charity generally are deductible for estate tax purposes. The effect of the marital and charitable deductions generally is to remove assets transferred to a surviving spouse or to charity from the estate tax base.
State death taxes: An estate tax deduction is permitted for death taxes (e.g., any estate, inheritance, legacy, or succession taxes) actually paid to any State or the District of Columbia, in respect of property included in the gross estate of the decedent.
Miscellaneous deductions: A deduction is available for funeral expenses, estate administration expenses, and claims against the estate, including certain taxes. A deduction also is available for uninsured casualty and theft losses incurred during the settlement of the estate.
Credits against tax
After accounting for allowable deductions, a gross amount of estate tax is computed. Estate tax liability is then determined by subtracting allowable credits from the gross estate tax.
Unified Credit - The New 2018 Federal Estate Tax Rules
The new rules double the Federal estate, gift and generation-skipping transfer (“GST”) tax exemption amounts from $5 million to $10 million per individual, with additional inflation adjustments as under prior law. The increased, inflation-adjusted exemption amounts – approximately $11.2 million for an individual, or a combined $22.4 million for a married couple – are effective for estates of decedents dying, and gifts made, after December 31, 2017 (with potential future inflation adjustments for 2019 and subsequent tax years), but are scheduled to expire on December 31, 2025, after which the relevant Federal estate, gift and GST tax exemption amounts would revert to the prior $5 million amounts, plus the relevant inflation adjustments.
Because the doubling of the estate and gift tax exclusion amount will expire for
decedents dying and gifts made after December 31, 2025, the next several years present an opportunity for wealthy individuals and married couples to make large gifts, including those that leverage the amount of the available exclusion, such as those to grantor retained annuity trusts (GRATs) and irrevocable life insurance trusts (ILIT's).
Estate tax credits also are allowed for: (1) gift tax paid on certain pre-1977 gifts (before the estate and gift tax computations were integrated); (2) estate tax paid on certain prior transfers (to limit the estate tax burden when estate tax is imposed on transfers of the same property in two estates by reason of deaths in rapid succession); and (3) certain foreign death taxes paid (generally, where the property is situated in a foreign country but included in the decedent’s U.S. gross estate).
Provisions Affecting Small and Family-owned Businesses and Farms
An executor can elect to value for estate tax purposes certain “qualified real property” used in farming or another qualifying closely-held trade or business at its current-use value, rather than its fair market value.
If, after a special-use valuation election is made, the heir who acquired the real property ceases to use it in its qualified use within 10 years of the decedent’s death, an additional estate tax is imposed to recapture the entire estate-tax benefit of the special-use valuation.
Installment Payment of Estate Tax for Closely Held Businesses
Under present law, the estate tax generally is due within nine months of a decedent’s death. However, an executor generally may elect to pay estate tax attributable to an interest in a closely held business in two or more installments (but no more than 10). An estate is eligible for payment of estate tax in installments if the value of the decedent’s interest in a closely held business exceeds percent of the decedent’s adjusted gross estate (i.e., the gross estate less certain deductions). If the election is made, the estate may defer payment of principal and pay only interest for the first five years, followed by up to 10 annual installments of principal and interest.