How Does Estate Tax Work?

Tax on Inheritance

The estate tax is a fee the federal government collects when a person dies and transfers his assets to another person or persons as specified by his will. Married couples need not pay estate tax, since each is considered an equal owner in the estate; most often the transfer of an estate is from the last surviving parent to his progeny. A federal gift tax is also in place, in part, to prevent an evasion of the estate tax through large transfers of wealth before the death of an aging estate owner.

Rate Based on Value of the Estate

Similar to the income tax rate, the tax rate on estates follows a progressive scale of taxation, from 18 percent for low value estates, up to 45 percent of the value of an estate that exceeds 2 million dollars. The value of the estate is determined by the summation of all assets property assets including monetary holdings, real estate, and investments as well as assets which the benefactor may not directly possess, such as life insurance money, and annuities. There is currently a unified credit in place for the estate tax, that essentially reduces the estate tax to zero for any estate worth less than 2 million dollars. This minimum amount is planned to increase to 3.5 million in 2009. It also should be noted that certain states asses an inheritance tax on top of the federal tax.

Other Considerations

Under the federal gift tax code, up to 12,000 dollars (twice that for a married couple) can be gifted to any number of beneficiaries each year (up to 345,000 dollars total for 1 year). By utilizing this gift allowance, one can spread some money to her progeny tax free, and possibly shrink the value of her estate below the threshold of the estate tax before she dies. The estate tax is one of the more controversial taxes in existence, as it is a tax on money and assets that were already taxed at some point in the past. Proponents of the tax cite the fact that beneficiaries of estates usually did not have to work for any of their assets they inherent, and that allowing tax free transfer of wealth will create a larger disparity of wealth between rich families and the middle class. Opponents cite the double taxation issue, and claim that such a tax presents a disincentive to work, especially in entrepreneurial activities that drive the economy which have high possible rewards. Some refer to the estate tax as the death tax in order to give it a negative connotation.