About the Federal Estate Tax

When you die, the property you leave behind (called an estate) may be subject to a federal estate tax for the right to pass the estate on to heirs and beneficiaries. Under pre-2010 law, there was no estate tax for the estates of individuals dying in 2010, but a modified carryover basis rule applied to the heirs who inherited property from such decedents. The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (12/17/10) retroactively restored the estate tax but allows the estates of individuals dying in 2010 an option to apply either (1) the pre-2010 Act rules (no estate tax with modified carryover basis) or (2) the new law rules for estates of individuals dying in 2011 or 2012, which provide a $5 million exemption and top rate of 35%, and full stepped-up basis for inherited assets.

Today, with home ownership, retirement plans, and other assets, you may be surprised to find that you are you may be at or exceed the dollar threshold and should learn about the estate tax.

What’s in an estate?

An estate consists of all assets you own or have a right to at the time of your death. These include a home you own, life insurance you own or have sufficient interests in, IRAs and retirement benefits, and a car. It also includes assets that would not produce taxable income on an income tax return, such as municipal bonds and Roth IRAs.

If you co-own assets, all or a portion of them may be included in your estate; it depends on who the co-owner is and other factors. Assets you haven’t yet collected but are owed to you at the time of death are also a part of your estate, such as a paycheck for work done before death and accrued interest on bonds.

Probate estate versus tax estate

Don’t confuse the concept of probate-the legal process of settling a decedent’s affairs under court supervision-with taxes. Assets included in a probate estate may be far fewer than those taken into account for taxes.

Probate assets include only those items held in your personal name and which do not pass automatically to a named beneficiary upon your death. For example, if you own stock in your own name, the stock is a probate asset. However, if you co-own stock with your spouse, with rights of survivorship, the stock is not part of your probate estate; it passes automatically under state law to your spouse. The stock, however, is still part of your tax estate.

Assets passing outside of a probate estate (exempt from probate but part of the tax estate) typically include:

• Annuities passing to a named beneficiary
• IRAs and qualified retirement plan benefits left to a designated beneficiary
• Life insurance passing to a named beneficiary (insurance left to the policy owner’s estate is part of probate)
• Living trusts, with assets passing to named beneficiaries of these trusts
• Property owned by joint tenants or tenants by the entirety (joint tenancy between a husband and wife), with rights of survivorship

Taxable estate may not be taxable

The fact that assets are included in your estate for tax purposes does not mean your estate will owe taxes. Transfers to a surviving spouse are completely tax free if certain conditions are met. For example, the estate of a person with $10 million who leaves her estate outright to her husband owes no estate tax.

Transfers to charity are completely tax free for estate tax purposes. While deductions for charitable gifts are subject to income limitations income tax, there is no cap on gifts to charity at death; they are fully deductible in figuring the estate tax.

Overview of estate tax computation

Figure the estate before tax (called the taxable estate) by amassing all assets, valuing them on the date of death (or opting for the alternate valuation date, which is six months after death), and then subtracting deductible amounts, such as assets passing to a surviving spouse or charity.

 Compute the tax on the taxable estate at rates up to 35% in 2011 and 2012. Every person can use a unified tax credit, which has the effect of passing up to $5 million tax free in 2011 and 2012. There are certain other estate tax credits that can offset any liability.

The estate tax return, Form 706, as well as any estate tax, is due nine months after death (extensions are allowed). An estate with assets above the $5 million exemption amount must file a return, even though deductions and credits erase any estate tax liability.