1. Estate Planning: Introduction
  2. Estate Planning: Estate Planning Basics
  3. Estate Planning: Introduction To Wills
  4. Estate Planning: Other Types Of Wills
  5. Estate Planning: Will Substitutes
  6. Estate Planning: Introduction To Trusts
  7. Estate Planning: Marital And Non-Marital Trusts
  8. Estate Planning: Charitable Trusts
  9. Estate Planning: Estate Taxation
  10. Estate Planning: Life Insurance In Estate Planning
  11. Estate Planning: Health Problems, Money Matters And Death
  12. Estate Planning: Conclusion

by Cathy Pareto, CFP®, AIF®

The estate tax is a type of "death tax", whereby taxes are imposed on the right to transfer or receive property at the property owner's death. This tax can come in the form of:

  • Inheritance tax
  • Estate tax, which is assessed on everything you own or have interest at the time of your death
The inheritance tax is generally imposed by some states on the recipient of inherited property as a right to receive wealth, while the estate tax, which is imposed at the federal level and in some states, is imposed on the decedent's estate for the right to transfer property. (Tax-Efficient Wealth Transfer can help higher net worth individuals reduce their estate taxes.)

The federal unified-transfer-tax system, which links the federal gift tax to the estate tax system, requires that all taxable gifts must be added to the taxable estate before calculating the estate tax due or applying any appropriate credits. In other words, if a decedent made taxable gifts above the annual exemption amounts of $12,000 per year (for 2008) it would have to be applied against their applicable exclusion amount, which is $2 million.

In general, a federal estate tax Form 706 must be filed for all decedents who are U.S. citizens or residents. The estate tax liability amount on Form 706 will be the total gross estate plus adjustable taxable gifts equaling or exceeding the amount of the applicable credit equivalent for the year of death. The executor of the estate is responsible for paying the tax.

An estate tax return for a U.S. citizen or resident needs to be filed only if the gross estate exceeds the applicable exclusion amount listed below.

Applicable Exclusion Amounts


Exclusion Amount

2007 and 2008




How are Taxes Calculated?
The calculation for the net estate tax due begins with the gross estate. The gross estate includes all of the assets owned by the decedent or the decedent's estate, including all probate assets (individual accounts, tenants in common, community property, etc.) and non-probate assets (joint accounts, life insurance, IRAs, etc.). The gross estate is then reduced by the following:
  • Funeral expenses.
  • Estate administration expenses.
  • Claims against the estate.
  • Unpaid mortgages on, or any indebtedness in respect of, property where the value of the decedent's interest is included in the value of the gross estate.
These amounts are subject to the laws that govern the jurisdiction in which the decedent resided.

The net figure becomes the "adjusted gross estate". Once the marital deduction and charitable deductions are subtracted from the adjusted gross estate, we arrive at the "taxable estate" figure. Then any taxable gifts are added (i.e., cumulative gifts made to individuals that exceeded the annual exclusion amount) to arrive at a "tax base". The tax base is then multiplied by the appropriate tax rate. For estates of decedents, and gifts made after 2006, the maximum rate for the estate tax and the gift tax for 2008 and 2009 is 45%, but the rate can range from 18% to 45% depending on the value of the taxable estate. Once the tentative tax is calculated, the amount is reduced by the applicable credit amount and any gift or state death taxes already paid. The result is the "net estate tax".

Individual taxpayers should work with a professional to ensure their estate taxes are computed accurately. Even the IRS has admitted that estate tax is one of the most complicated areas of the tax code, and encourages taxpayers to work with an estate tax practitioner who has considerable experience in the field.

Valuing Assets
Estate assets are valued at fair market value unless special-use valuation is employed (i.e., business interests, closely held companies, etc.). Most properties that are bequeathed through an estate receive a "step-up in basis", meaning that the cost basis of the inherited property assumes a date-of-death valuation. This is an incredible boon for the person who inherits property that once had a low cost basis, which would have subjected them to higher potential capital gains.

For example, Mary owns $200,000 of IBM (NYSE:IBM)stock in her portfolio, but her adjusted purchase price is only $40,000. Her potential capital gain, if sold, is $160,000. Let's say Mary dies and leaves her son Joe all the IBM shares, for which the date-of-death value is $200,000. Joe's cost basis now becomes $200,000, and not Mary's $40,000, so if he decides to sell the stock the next week when the stock is worth $205,000, his capital gain would only be $5,000! That's the benefit of receiving a step-up in basis.

In order for certain transferred or gifted assets to remain out of the estate, they must pass the three-year rule. This applies to transfers of life insurance by the insured and any gift tax paid out-of-pocket on gifts within three years of death.

Estate Planning: Life Insurance In Estate Planning
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