Planning Your Estate/The Federal Estate Tax

Nature of the Estate Tax

      The federal estate tax is imposed upon the transfer of a decedent's property to beneficiaries. It is imposed upon the value of the entire estate, which is liable for its payment.

      Careful planning during life is important to minimize the impact of the tax and to prepare estates for the burden of payment.

      Whether your estate will pay a federal estate tax depends upon the estate value and the amount of deductions and credits available for your situation. The taxable estate is derived by subtracting the allowable expenses and deductions from the gross estate.

      This publication presents a general explanation of the federal estate tax provisions of the Tax Reform Act of 1976, the Revenue Act of 1978, the Economic Recovery Act of 1981, and the Taxpayer Relief Act of 1997. In general, these laws add certain valuation methods, change the definition of the taxable estate, and change the computation of the estate tax.

Gross Estate

      The gross estate includes the fair market value of the following items:

      Property owned by the decedent -- Property owned by the decedent includes real and personal property. Examples include real estate, stocks, bonds, bank accounts, promissory notes, furniture, jewelry, personal effects, and interests in partnerships or unincorporated businesses.

      Transfer with retained life estate -- The value of the gross estate includes property transferred by the decedent after March 3, 1931, but before death, if the decedent retained possession or enjoyment of the property or reserved certain rights or interests. However, if the transfer were made for an adequate and full consideration in money or money's worth, it is not included in the gross estate.

      Example: Jack deeded his farm to his son and daughter-in-law. However, Jack continued to live on the farm, continued to make management decisions, and continued to receive income from the operation. In this case, the Internal Revenue Service concluded that Jack retained a life interest. The value of the farm was included in Jack's gross estate when he died.

      Transfers taking effect at death -- The gross estate includes the value of property interests transferred by the decedent after September 7, 1916, unless the transfer was made for an adequate and full consideration in money or money's worth, if all of the following conditions exist:

1. Possession or enjoyment of the property transferred could have been obtained by the beneficiaries, through ownership of the property, only by surviving the decedent;
2. A reversionary interest in the property was retained by the decedent; and
3. The value of the reversionary interest immediately before the decedent's death exceeded five percent of the value of the entire property.

      Example: Assume Mike transferred property in trust with the income payable to his wife for life and the remainder payable to himself or, if he is not living at his wife's death, to their child or the child's estate. This illustrates the retention of a reversionary interest by the express terms of the trust. Mike had expressly retained the right to have the property returned to himself in the event he survived his wife, a right that he possessed up to the moment preceding death.

      Revocable transfers -- The gross estate includes the value of property interests transferred by a decedent (unless the transfer was made for adequate and full consideration in money or money's worth) if the enjoyment of the property transferred was subject, on the date of death, to any power of the decedent to alter, amend, revoke, or terminate the transfer. An example of a revocable transfer is a revocable trust.

      Annuities -- The gross estate includes the value of an annuity or other payment receivable by any beneficiary, by reason of surviving the decedent, if the value of the annuity or other payment is attributable to contributions made by the decedent or the decedent's employer. A pure annuity contract that provides periodic payments to a person for life and ceases at the person's death is not included in the gross estate.

      Joint interests -- The Economic Recovery Act of 1981 made a change with respect to property owned jointly between spouses. If property is held by a husband and wife as joint tenants, the estate of the first spouse to die includes one-half of the value of property, regardless of which spouse furnished the consideration for the acquisition of the property. This change is effective on estates of decedents dying after December 31, 1981.

      Example: In 1962, Darrel purchased a farm for $200,000 with his own funds and took title in joint tenancy with right of survivorship with his wife Carol. When Darrel died in 1982, the farm had increased in value to $800,000. One half of the value, $400,000 was included in his estate for determining the federal estate tax.

      In the case of property owned at the time of the decedent's death by the decedent and a person or persons (other than the decedent's spouse) with the right of survivorship, the gross estate includes the full value. An exception is allowed to the extent the surviving joint owner or owners can prove their portion was acquired for adequate and full consideration in money or money's worth or by bequest or gift from a third party.

      Example 1: Paul placed his farm, valued at $900,000, in joint tenancy with right of survivorship with his son Ryan. Upon Paul's death the entire amount was included in his estate in determining the federal estate tax, because Ryan could not prove he contributed to the purchase price.

      Example 2: When William and his son John bought a farm for $100,000, they used $50,000 of John's funds. When William died, the farm was worth $250,000. The value, included for federal estate tax purposes, was only $125,000, because that was the portion (50 percent) William had contributed to the purchase price.

      The burden of proof is on the decedent's estate to prove the amount and source of contribution on the part of the surviving joint owner or owners unless the decedent and surviving joint owners are spouses. Records are needed to document when the property was acquired, what consideration was furnished, and by whom. In the absence of such records, the full value of the property will be subject to federal estate tax.

      Powers of appointment -- The gross estate includes the value of property interests over which the decedent possessed a general power of appointment at death. A power of appointment is a power to determine who shall own or enjoy, presently or in the future, the property subject to the power. A general power of appointment is one in which a decedent could have appointed the property subject to the power to himself, his creditors, his estate, or his estate's creditors. It includes the unlimited power to consume, invade, or appropriate income or principal, or both, for the benefit of the decedent.

      Example: Carl was given the power to appoint the principal of a trust to any of six persons, excluding himself. He also was given the power to invade the principal for any reason for his own benefit. Carl has a general power of appointment. However, if Carl's power to consume or invade the principal for his own benefit had been limited to an ascertainable standard relating to health, education, support, or maintenance, then his power would not have been a general power of appointment.

      Proceeds of life insurance -- The gross estate includes the proceeds of life insurance on the decedent's life if: 1) the proceeds are receivable by the estate; 2) the proceeds are receivable by another for the benefit of the estate; or 3) the decedent possessed incidents of ownership in the policy (e.g., the power to change beneficiaries, to revoke an assignment, to pledge the policy for a loan, or to surrender or cancel the policy).

      Life insurance on the life of another, owned by the decedent at the decedent's death, is included in the gross estate as property owned at death. The amount includible is the replacement value of the policy that can be obtained from the life insurance company.

      Transaction within 3 years of death -- Generally, the value of gifts (other than gifts of life insurance) made by a decedent within 3 years of death is not included in the gross estate. The Economic Recovery Act of 1981, however, requires that interests in property otherwise includible in the gross estate under the so-called "strings attached" section are still included in the gross estate if transferred within 3 years of death. Examples of such interests include transfers with retained life estate, transfers taking effect at death, revocable transfers, and powers of appointment.

Valuation

Generally, the value of the decedent's property for estate tax purposes is its fair market value at the date of death. The fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of all relevant facts. Instead of valuing the decedent's property for estate tax purposes at the date of death, the executor may elect to value the assets as of six months after the decedent's death, or as of the date of its distribution, sale, exchange, or other disposition, whichever date occurs first. This is called alternate valuation.

      A third type of valuation, current use valuation, allows a farm (or other closely held business that transfers to qualified heirs) and is continually farmed or run as before to be valued at the use value and not the market value. If the executor elects to have property valued at current use value, the gross estate cannot be reduced by more than $750,000. Beginning in 1999, this $750,000 ceiling on special use valuation is indexed annually to reflect inflation. This provision applies to estates of taxpayers dying after December 31, 1997. (A detailed explanation of current use valuation and its requirement is in Extension Publication 1373, "Estate Planning: An Investment in Your Family's Future.")

Taxable Estate

      As mentioned earlier, the taxable estate is derived by subtracting the allowable expenses and deductions from the gross estate. Examples of allowable expenses include administration and funeral expenses, claims against the estate, outstanding obligations, and casualty and theft losses. Examples of allowable deductions include the marital and charitable deductions.

Administration and Funeral Expenses
      Administration expenses in-clude the compensation to the executor, fees of the attorney for handling legal aspects of the estate, and miscellaneous costs-accountant's fees, court costs, selling expenses for selling the estate property (if these sales are necessary to settle the estate), and excise taxes incurred in these sales. Funeral expenses are deductible. Medical expenses, if deducted only on the estate tax return, are fully deductible as administration expenses.

Claims Against the Estate
      These include all debts of the decedent such as property taxes accrued before the decedent's death, unpaid income taxes on income received by the decedent during life, and unpaid gift taxes on gifts made by the decedent during life. Mississippi and federal estate taxes are not deductible.

Obligations
      Unpaid mortgages and other charges against property, including the interest accrued to the date of the decedent's death, are deductible if the value of the property is included in the gross estate without reduction for the mortgage or other indebtedness.

Casualty and Theft Loss
      Deductions are allowed for losses incurred during the settlement of the estate, arising from theft or casualties, such as storms or fires. This is only to the extent, however, that these losses are not compensated for by insurance or in another manner.

Marital Deduction
      The Economic Recovery Act of 1981 eliminated the monetary ceiling on the estate marital deduction for estates of decedents dying after 1981. Thus, unlimited amounts of property (except for certain terminable interests) can be transferred between spouses free of estate tax. Utilizing the unlimited marital deduction at the death of the first spouse, however, may result in higher taxes at the death of the second spouse. By utilizing a partial marital deduction, it is possible to minimize estate taxes at the death of both spouses.

      Example: One of Marvin and Wanda's estate-planning objectives is to minimize taxes. They had read newspaper reports about the unlimited marital deduction and thought, "Now we no longer need to plan." Wanda decided to consult their tax accountant and attorney "just in case." The professionals provided the following illustration:

      Situation A: Assume that in 1991 Marvin dies leaving an estate valued at one million dollars. By utilizing the unlimited marital deduction, the estate pays no tax at Marvin's death. However, upon Wanda's death two years later, a $153,000 federal estate tax results.

      Situation B: Assume that in 1991 Marvin dies leaving an estate valued at one million dollars equally divided between Wanda and his daughter Connie. There is no estate tax at the death of either spouse because the couple utilized a partial marital deduction.

Charitable Deduction
      A deduction is allowed for the value of property in the decedent's gross estate that was transferred by the decedent during life or by will to a "qualified" charitable, religious, educational, or governmental organization. The Internal Revenue Service publishes a list of qualifying organizations.

Computation and Rates of Estate Taxes

The following steps are taken in determining federal estate taxes due:

1. Determine the taxable estate. The taxable estate is the gross estate less the allowable expenses and deductions.
2. To the taxable estate, add the value of adjusted taxable gifts. These gifts include only the value of the taxable gifts made by the decedent after 1976 that are not includible in the decedent's gross estate. This gives the taxable interests.
3. Compute a tentative tax on the taxable interests using the rates in Table 1, Extension Publication 1743.
4. From the tentative tax, subtract any tax payable on gifts made after 1976. The remaining amount is referred to as the estate tax before credits.

Credits Against the Tax

      From the estate tax before credits, the following credits are deducted to determine the net estate tax payable: unified credit, credit for state death taxes, credit for pre-1977 gift taxes, and partial credit for tax on prior transfers.

Unified Credit
      Beginning in 1998, the unified estate and gift tax credit will increase annually, until the maximum value of estates exempt from tax reaches $1 million in 2006. To the extent the unified credit is used on gifts, the amount of credit actually available at death is reduced. The Taxpayer Relief Act of 1997 increased the unified credit according to the following phase-in schedule.

Unified tax credit

Death in	Credit	Equivalent exemption*
1998	$202,050	$625,000
1999	211,300	650,000
2000 & 2001	220,550	675,000
2002 & 2003	229,800	700,000
2004	287,300	850,000
2005	326,300	950,000
2006 & after	345,800	1,000,000

*Indicates the value of an estate that may pass
without an estate tax due.

Credit for State Death Taxes
      The tentative tax may be further reduced if any estate, inheritance, legacy, or succession tax is actually paid to any state or the District of Columbia on any property included in the gross estate of the decedent. The allowable credit is computed using the adjusted taxable estate rather than the taxable estate. The adjusted taxable estate is the taxable estate reduced by $60,000.

Credit for Gift Taxes
      No credit is allowed for any gift tax paid on gifts made after 1976. Credit is allowed against the estate tax for the federal gift tax paid on a gift made before 1977 by a decedent of property subsequently included in the gross estate.

Credit for Tax On Prior Transfers
      Partial credit is allowed against the tax for federal state taxes paid on the transfer of property to the present decedent from a transferor who died within 10 years before, or within 10 years after, the present decedent's death.

Filing

      Form 706 United States Estate Tax Return, if required, is due 9 months after the date of the decedent's death. The estate tax return must be filed if the gross estate of a decedent exceeds $600,000.

A reasonable extension of time (not to exceed 6 months) to file the estate tax return or related statements or documents may be granted if it is impossible or impractical to complete the return within the normal 9-month period. An extension of time to file is not an extension of time to pay. An estimate of the tax due will be required to be paid with the extension unless one of the deferred payment plans is elected.

Extension of Time to Pay
      1-Year extensions - An executor or administrator may request an extension of time for paying the estate tax for a period not to exceed 12 months from the date fixed for the payment, and such a request will be granted whenever there is reasonable cause.

      Ten 1-year extensions - In addition, the executor or administrator, when showing reasonable cause, may be granted an extension of time for a period not to exceed 1 year for any one period and for all periods not to exceed 10 years from the due date of the original return for payment of the tax liability.

      When estate consists largely of closely held business - If the value of the closely held business interest exceeds 35 percent of the adjusted gross estate, the executor or administrator may elect to defer the estate taxes attributable to that interest. The estate makes an annual interest payment for a period not to exceed 5 years; thereafter, paying the balance in up to 10 annual installments of principal and interest. A special 4-percent interest rate is provided for deferred tax attributed to the first $1,000,000 in value of the closely held business interest. Deferred taxes attributable to any excess value carries the regular interest rate. The rate is 20 percent.

More Information

For more information about federal estate and gift taxes, read the Internal Revenue Service Publication 448 (1982 Revised), "A Guide to Federal Estate and Gift Taxation." This 56-page booklet can be ordered from the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402.

References

Information in this series is adapted from Estate Planning for Every Montanan by Marsha A. Goetting, Montana Cooperative Extension Service.

Lynn, Robert J. Introduction to Estate Planning. St. Paul, Minn., West Publishing Co., 1981.

Martin, Robert J."Estate Planning: An Investment in Your Family's Future," Publication 1373, Cooperative Extension Service,
      Mississippi State University, 1990.

Milner, Dorothy Leggett. "An Introduction to Estate Planning." Research paper, Mississippi State University, 1978.

Mississippi Code 1972 (Annotated), Vol. 20, Title 91, Sections 91-1-1 through 91-7-1.

State of Mississippi Estate Tax Law, Mississippi State Tax Commission, 1978.

By Beverly Riggs Howell, Ph.D., Family Economics and Management Specialist.

Mississippi State University does not discriminate on the basis of race, color, religion, national origin, sex, age, disability, or veteran status.

Publication 1745

Extension Service of Mississippi State University, cooperating with U.S. Department of Agriculture. Published in furtherance of Acts of Congress, May 8 and June 30, 1914. Ronald A. Brown, Director

Copyright by Mississippi State University. All rights reserved.

This document may be copied and distributed for nonprofit educational purposes provided that credit is given to the Mississippi State University Extension Service.

Visit: DAFVM || USDA
Search our Site || Need more information about this subject?
Last Modified: Friday, 07-Sep-07 13:20:54
URL: http://msucares.com/pubs/publications/p1745.htm
Mississippi State University is an equal opportunity institution.
Recommendations on this web site do not endorse any commercial products or trade names.