The Federal Estate Tax is a transfer tax that an estate may have to pay before it can be distributed to its heirs or beneficiaries. The estate tax must be paid within nine months from the date of death of a deceased person. The estate tax is computed on almost everything owned by an individual at death. This includes one’s home, business interests, bank accounts, investments, personal property, IRAs, retirement plans, and death benefits from life insurance policies payable to or owned by the estate. These items are reduced by one’s debts at death, expenses of administration of the estate (such as executor, legal, and accounting fees), certain medical expenses, funeral expenses, marital and charitable deductions, and certain losses. The value of the estate after deductions is subject to the estate tax to the extent it exceeds the exemption amount established by Congress and in effect at the time of death.
In other words, a lifetime exemption against estate taxes is allowed to each individual, and there is no estate tax on assets owned at death to the extent that the asset value does not exceed the exemption as of the decedent’s date of death. In 2002, the exemption amount was $1,000,000 per person. The amount gradually increased to $3,500,000 per person in 2009. In 2010, the estate tax was temporarily repealed and then reinstated by the 2010 Tax Act. The American Tax Relief Act of 2012 set the exemption amount at $5,000,000, adjusted for inflation, and in 2017, the exclusion was $5,490,000, in 2018 it was $11,180,00 per person and in 2019, $11,400,000. This exemption “sunsets” on January 1, 2026, with the exemption returning to 2017 level. It is an understatement to say that politics play a role in setting the lifetime exclusion amount and the top marginal rate (40% in 2019).
The estate tax is a separate expense from income taxes and probate expenses, which also reduce the value of the estate passing to loved ones. A married couple that have a combined estate greater than the exemption amount can reduce or eliminate estate taxes by ensuring that the exemption of both spouses is utilized. This is done by adding a Bypass Trust to your revocable trust, either with an AB Trust, an ABC Trust or a Disclaimer Trust, or by electing Portability after the first death.