Benjamin Franklin told us that only two things are certain in life: death and taxes. One form of taxation, which encompasses both, is the federal estate tax, also called the death tax.
The current federal estate tax goes back to 1916, although death taxes of one form or another go back to the Revolutionary War. Death taxes come in two forms: state inheritance tax and the federal estate tax. Tennessee abolished its state inheritance tax in 2016; Arkansas and Mississippi currently have no inheritance tax. The only applicable death tax in these states is the federal estate tax.
What assets are subject to federal estate tax?
The easy answer to this question is everything. Your home, bank accounts, investments, retirement assets and even life insurance are generally part of your estate for federal estate tax purposes. This is the case whether the assets are held individually or jointly with a spouse or children.
Since 1981, no federal estate tax is produced by reason of assets which pass outright or in certain specialized trusts to or for the benefit of a surviving spouse who is a U.S. citizen. Such assets are, however, taxed at the surviving spouse’s later death.
Each of us is granted an exemption from death tax under the law. The current exemption is approximately $5.5 million. If the value of the estate passing to persons other than a spouse exceeds the exemption, the excess assets are subject to federal estate tax. The current tax rate is 40%. For example, a $6 million estate would be subject to approximately $200,000 in federal estate tax; a $10 million estate would be subject to approximately $1.8 million in tax.
Each spouse has an estate tax exemption. However, upon the death of a spouse, unless actions have been taken during the deceased spouse’s lifetime and a federal estate tax return (Form 706) is filed shortly after the death of the first spouse, the exemption of the first spouse may be lost, leaving the surviving spouse with only his/her separate exemption. Proper planning and execution of an estate plan can result in two exemptions being used or approximately $11 million passing to children free of federal estate tax. For those who have estates exceeding $11 million, other planning techniques may greatly reduce the tax liability at death.