Personal Finance

The Estate Tax

part of a form titled "estate tax return" with a pencil above it

"The man of great wealth owes a peculiar obligation to the State, because he derives special advantages from the mere existence of government. Not only should he recognize this obligation in the way he leads his daily life and in the way he earns and spends his money, but it should also be recognized by the way in which he pays for the protection the States gives him."

-- Theodore Roosevelt

Once you're deceased, Uncle Sam grows interested in the net value of your property. Specifically, when your estate is transferred to your heirs upon your death, there may be a federal and/or state estate tax due.

part of a form titled "estate tax return" with a pencil above it

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The estate tax, in a nutshell

The good news regarding estate taxes on your property is that you don't have to pay them -- because you're deceased. Estate taxes might present a headache and cash outflows for your heirs, though -- but they probably won't. That's because while many people rail against estate taxes, extremely few people ever have to pay them. The federal and state taxes are only directed at the most affluent people, with the most valuable estates.

Here's how the IRS introduces the topic:

The Estate Tax is a tax on your right to transfer property at your death. It consists of an accounting of everything you own or have certain interests in at the date of death ( Refer to Form 706 (PDF)). The fair market value of these items is used, not necessarily what you paid for them or what their values were when you acquired them.
someone holding a small blackboard on which "what you need to know" is written

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What you need to know about estate taxes

Here are a few key things to understand about the tax that targets the property of the deceased:

What's taxed : The value of what is subject to taxation is your gross estate, less a few allowed deductions. Assets that count include cash, stocks, real estate, vehicles, business interests, life insurance proceeds, and annuity income, among other things. The kinds of things you can deduct from this gross value include any debt obligations that still need to be met, the value of donations to be made after death, the value of assets that are transferred to a surviving spouse, and funeral expenses. There can be a little added to the taxable net value, too -- if you gave anyone gifts that exceed the annual limitations, those amounts are generally added back. (Note, for example, that you can currently give up to $14,000 to someone over the course of the year.)

The exemption : If it's seeming that your estate is likely to face the estate tax, hold on. There's an estate and gift tax exemption that serves to excuse most taxpayers from the estate tax. It's adjusted from time to time to keep up with inflation. For 2017, the exemption is $5.49 million per person. If you leave $5.49 million or less to your heirs, there will be no federal estate or gift tax. For a married couple, both spouses get the same exemption, giving them a total amount of nearly $11 million. Clearly, most people's assets fall far below these limits, leaving them untouched.

The tax bite : So if you do have to face the estate tax, how much will you have to fork over? Well, the estate tax rate is 40% at the time of this writing. It has changed over time, and some in Washington have great interest in repealing it altogether.

Here's what the estate tax has looked like at a few points in the past (the table is not comprehensive):

Period Estate Tax Rate
September 1916 to March 1917 10% of net estate in excess of $5 million
February 1919 to February 1926 25% of net estate in excess of $10 million
May 1934 to August 1935 60% of net estate in excess of $50 million
September 1941 to August 1954 77% of excess of net estate over $10 million
1982 65% of excess over $4 million
2006 46% of excess over $2 million
2010 No estate tax
2011 35% of excess over $5 million
2017 40% of excess over $5.49 million

Sources: and

State estate taxes : Most people focus on the federal estate tax, but there are a bunch of states that levy an estate tax, too, with exemptions of various sizes. Their ranks change over time -- with, for example, New Jersey eliminating its estate tax as of 2018.

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Arguments for and against

When people argue over the merits of the estate tax, proponents will often claim that much of what's taxed was never taxed before -- such as a business that grew valuable over decades or unrealized capital gains from investments and that the tax can help keep wealth from being concentrated in just a few hands. They note that those being taxed have typically received a windfall inheritance that isn't the product of their toiling and that it's reasonable to raise valuable revenue via a tax on that. They also point out how few people are even affected by the tax and that the very wealthy have benefited from government regulations.

Those against the tax will point out some people who seem unduly hurt -- such as those who might have inherited a business or interest in a business and be unable to pay the tax without selling the business. They also see it as unfair that assets are valued at their fair market value even though they may have been purchased for far less.

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What to do

If you believe that the estate tax will come into play (at the federal and/or state level) once you join the ranks of the deceased, you would do well to engage in some estate planning. Read up on the estate tax rules to see just how big your taxable estate is likely to be and how it will be calculated. It's smart to consult with a professional financial advisor or two, as well -- because large estates can be managed to a great degree, and you may be able to take some actions now that will shrink your estate enough to significantly reduce or eliminate the tax hit. Some ways to shrink your taxable estate include making tax-exempt gifts and employing trusts.

It's always good to know about and understand the estate tax, but for most of us, it's largely an academic exercise.

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