The term “inheritance tax” is very misleading. Contrary to popular belief, taxes are not levied against the beneficiaries based on what they inherit. Instead, they're levied against a decedent’s estate before it’s distributed to the beneficiaries -- that's why the IRS refers to it as an “estate tax.” Many other misconceptions surrounding the estate tax have a lot of people wondering how to structure their own assets so they can best provide for their own heirs. The facts of the matter may surprise you – and set your mind at ease.
Fact and Fiction
Who is affected by the estate tax? The subject of taxes is a hot-button issue, and it can be difficult to separate the facts from the hype generated in the heat of a political debate. The “estate tax” was rebranded the “death tax” by its opponents to make it sound more unacceptable to more people. After all, the word, “estate” is associated with the rich, and many think that rich people already have enough ways of getting out of paying taxes, with tax shelters, offshore accounts and loopholes. But because death is something that affects everyone, it has a wider negative appeal: By combining death and taxes, you have a buzz phrase that may attract more potential opponents. But the simple fact is that 99.7 percent of all Americans are not affected by the estate tax.
How rich do you have to be before your estate is subject to an estate tax? If your wealthy uncle passed away in 2010 or later, his estate would have to be worth more than $5 million for it to be subject to the estate tax – and even then, it’s only the amount over $5 million that is subject to the estate tax. What’s more, many deductions, exemptions and other considerations are excluded. For instance, all property that passes from the decedent to a spouse is eligible for the marital deduction. All property left to a qualifying charity is also deducted from the value of the estate when computing the estate’s total gross value.
Filing a Return
How do you determine if you must file an estate tax return? The executor of the estate must arrange for the estate to be valued. If its gross value meets the taxable threshold, he must file Form 706 with the IRS and pay any tax due within nine months of the decedents death. The form does not need to be filed if the gross value of the estate does not meet the minimum threshold. Only estates valued at over $5 million have to file an estate tax return; less than half of those will owe any tax.
What property is considered part of an estate, and how is its value determined? Property consists of cash, securities, real estate, insurance, trusts, annuities, business interests and other assets. For purposes of determining the value of the estate, valuation is considered to be the decedent’s share of any jointly owned property. The value of each asset is based on its fair market value, or what it can be sold for at an estate sale, not what was paid for it when it was purchased. Once the value of all the property has been determined, the amount of any outstanding debts, such as mortgages on property, must be subtracted to determine if the estate meets the taxable threshold.
Lisa Dorward was a corporate financial executive and business consultant for more than 15 years before becoming a writer in 2003. She has B.A. degrees in both history and creative writing and earned her M.F.A. in creative writing in 2008, specializing in novel-length historical fiction.