Regardless of how property passes at death, for estate tax purposes a decedent's "taxable estate" will include the value, at the time of death, of all interests in property owned by the decedent, real or personal, tangible or intangible, wherever situated. This includes automobiles, other vehicles (e.g., boat, airplane, motorcycle, snowmobile, etc.), artwork, jewelry, precious metals, coins, stamp collections, furniture, furnishings, clothing, etc. (collectively, "tangible personal property"), as well as the decedent's home, other real property, bank accounts, certificates of deposit, annuities, stocks, bonds, mutual funds, interests in other entities (e.g., general or limited partnerships, limited liability companies, etc.), retirement plan proceeds (in some situations), and the death benefit proceeds of life insurance policies owned by the decedent.
Generally, for estate tax purposes the decedent's property will be valued at its "fair market value" ("FMV") on the date of the decedent's death. FMV is the price at which property would exchange hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts. The FMV of an item of property is typically determined by reference to the property's highest and best use, not its current use.
For estate tax purposes, the decedent's estate will be entitled to deduct the decedent's funeral expenses, estate administration expenses, and the debts of the decedent's estate. In addition, the decedent's estate also will be entitled to certain other exemptions, deductions, and credits discussed in more detail below.
The estate and gift tax system in the United States is "unified." That is, when computing the amount of tax due upon a person's death, the IRS will also take into consideration transfers made by the decedent during his/her lifetime. Generally, four tools are available to reduce the amount of estate and gift taxes a person may owe:
1. $10,000 Annual Exclusion - each calendar year a person is permitted to give up to $10,000 tax-free to each of any number of individuals other than the decedent's spouse. For example, if a person has ten children, she may give up to $10,000 per child, per year, without gift taxes being imposed.
2. Applicable Exclusion Amount - Each of us is entitled to make taxable transfers during lifetime and at death of property having an aggregate value equal to the then applicable exclusion amount. Property transferred in excess of that amount will be taxed at rates starting at 37% and growing to 55%, depending upon the value of the property transferred. The amount of the applicable exclusion depends upon the year in which a gift is made or a death occurs, as follows:
- YEAR OF GIFT OR DEATH
- APPLICABLE EXCLUSION AMOUNT
- 2000 and 2001
- $675,000
- 2002 and 2003
- $700,000
- 2004
- $850,000
- 2005
- $950,000
- 2006 and thereafter
- $1,000,000
After the year 2006, the Applicable Exclusion Amount will be indexed for inflation. For purposes of the following discussion, the $675,000 amount applicable in 2000 will be used, but in future years a person should consider the larger Applicable Exclusion Amount then available.
3. Unlimited Marital Deduction - a person may give unlimited amounts of property to the decedent's spouse during the decedent's lifetime and at death without incurring any gift or estate tax.
4. Unlimited Charitable Deduction - a person may give unlimited amounts of property to qualified charities at death without incurring any gift or estate tax.
How the unified gift and estate tax system works may best be described by example. Let's assume Mom made a gift of $25,000 to each of her two children during 1999. Let's assume Mom again makes similar gifts to her two children in 2000. Finally, lets assume Mom dies in the year 2001, without having made any further gifts.
In 1999, the first $10,000 of each gift was tax-free (because of the $10,000 annual exclusion) and Mom will have made taxable gifts in the aggregate amount of $30,000 (2 X ($25,000 - $10,000)). However, Mom will not have to actually pay any gift taxes with respect to those gifts. Instead, Mom will file a gift tax return, report the gifts made, and elect to apply a portion of her Applicable Exclusion Amount to the gift taxes owed.
Similarly, in 2000, Mom will have made taxable gifts in that year in the aggregate amount of $30,000. Again, Mom will file a gift tax return, report the gifts made and elect to apply a portion of her Applicable Exclusion Amount to the gift taxes owed.
At the time of her death in the year 2001, Mom will have made taxable gifts during her lifetime in the aggregate amount of $60,000. Accordingly, she will have used up that portion of her Applicable Exclusion Amount available to her in that year ($675,000), and $615,000 of her Applicable Exclusion Amount will then be available to her estate. To the extent that the value of her estate exceeds that amount at her death, estate taxes will accrue.