Estate Taxes: Federal and State

Federal and state estate taxes are taxes on your ability to transfer property upon your death. These taxes consist of an accounting of all property and assets you own or have an interest in at the time of your death.

Federal and state estate taxes are calculated differently and are subject to different exemption limits. However, most calculations take into account the fair market value of the items in the estate, not what was paid for them. The total value of all items is known as the gross estate. Items such as property, cash, equities, bonds, real estate, insurance policies, trusts, annuities, business interests, and all other assets are included in the gross estate. While estate taxes can't always be eliminated completely, they can be reduced substantially.

ยป Speak to a Financial Advisor in Your Area for Free

What is Included in My Estate?

Your gross estate consists of everything you own or have an interest in at the time of your death. The fair market value of all of your property and assets at the time of your death is used to calculate the value of the estate, not what you paid or what the values were when you got them. The total of all of your property and assets is your gross estate. The property and assets consist of cash and securities such as stocks and bonds, real estate, insurance policies, revocable and irrevocable trusts, annuities, any business interests, and all other assets, including cars and furnishings. If property and assets are not kept within a trust, the gross estate will include items that will go through probate as well.

What is Not Included in My Estate?

Generally, your gross estate will not include property owned only by your spouse, children, or other individuals. Neither are lifetime gifts included in the gross estate. Life estates that were given to or inherited by the decedent for which he or she has no further control of at death are also not included.

Deductions Available to Reduce the Gross Estate

Depending on the size of the estate and the estate tax laws that apply for the year in which the death takes place, it's always a good idea to meet with a qualified estate attorney. He or she should be able to help reduce the amount of tax liability and make sure that all assets are properly accounted for prior to filing the return.

After the gross estate is established, certain deductions are allowed in order to arrive at the taxable estate. Deductions can include a mortgage and other debt, service charges and administration expenses, property that passes from a deceased spouse to a surviving spouses, and property that passes to a qualified charity.

After the taxable amount is calculated, an individual is allowed to reduce the estate by the allowable exemption limit. The exemption limit changes periodically with Congress and is alternately known as the estate tax, inheritance tax, or death tax. Small estates that contain only cash, equities, bonds, and other easily valued assets rarely require the filing of an estate tax return. The filing is required, however, for estates that are valued at more than the allowable exemption limit, and for estates that include jointly held property, and certain business interests.

Additional Deductions Available to Reduce Estate Taxes

The marital allows property and assets to pass to the surviving spouse free of the estate tax. However, the property and assets must pass to the spouse outright. Charitable donations also often qualify for a deduction, as do outstanding mortgages and debt, administration expenses of the estate, and losses that occur during estate administration.

Determining Fair Market Value

Fair market value is the price at which the property or asset would change hands between a willing buyer and a willing seller at the time it is sold. In other words, fair market value is the price a seller would sell an asset for under normal market conditions and not under duress. In most cases, the fair market value of the items owned by the decedent are included in the gross estate at time of his or her death.

Filing the Federal Estate Tax Return

The representative of the estate must file the return within nine months of the death. He or she may request an extension of time to file for up to six months from the time the return is due. However, the tax that is due must be paid within the nine month time period.

State Estate Taxes

Several states assess estate taxes on real estate owned by a decedent within the state. Most states also assess estate taxes on the personal property of the deceased as well. One tax rate might apply to all assets in the estate, or tax rates could vary depending upon the type of property and who receives it. For example, one state might assess a lower tax rate on property, including cash that is left to a minor child, than it will on property that is left to a niece or nephew.

Assessing State Estate Taxes

Because state estate tax laws can be different in the state in which the decedent and beneficiary live, it is always a good idea to review your estate plan with a qualified attorney prior to executing the plan. However, in most states that have inheritance or estate tax laws, the beneficiary who receives the property pays any and all taxes that are due. There might be exemptions available and rates might vary depending on who receives the property.

What is the Pickup Tax?

In most states, even if they technically have estate or inheritance tax laws to assess taxes, for the most part they follow a practice known as a "pickup" system of taxation that occurs at the time the estate owner dies. Under the pickup system, the estate administrator must file a separate state tax return on behalf of the estate. Alternately, the beneficiary who inherits the property and assets can file the return. The state's share of the tax is paid out of what the estate has already paid to the Internal Revenue Service. In other words, most states will not collect any additional tax beyond what has already been paid to the federal government.

While we've covered the basics of estate planning here, there is much more to implementing a solid estate plan. To make sure you're on the right track, contact a licensed financial advisor. It only takes a few minutes, Start Now.

More Estate Planning Guidance