What is an estate tax? How much can I leave without being subject to estate tax?

The federal estate tax is a tax imposed on the transfer of assets and property upon death.  Think of it as an ‘everything’ tax—as in, everything you own will be counted including bank accounts, brokerage accounts, retirement accounts, real estate, personal property and automobiles, business interests, stocks and bonds and death benefits of any life insurance policies. 


Life insurance benefits, in particular, tend to frequently be overlooked.  Many people are told that life insurance proceeds are tax-free.  And in some ways this is true, but it is also misleading.  The beneficiary of your life insurance policy will not have to pay any income taxes on the death benefits that he or she receives, but the death benefits will count as part of your gross taxable estate.

So, for example, if you have a $1 million life insurance policy, you already have at least a $1 million gross taxable estate before we even start factoring in your bank accounts, real estate, retirement and other assets.

Every person is allowed an estate tax exemption, or in our office we call it your estate tax “coupon.”  It is the amount that you can pass on without paying any estate taxes.  Over the past few years, the estate tax exemption and the estate tax rate applied to amounts in excess of the exemption has been fluctuating pretty significantly:

Year

Estate Tax Exemption

Top Estate Tax Rate

1997

$600,000

55%

1998

$625,000

55%

1999

$650,000

55%

2000

$675,000

55%

2001

$675,000

55%

2002

$1,000,000

50%

2003

$1,000,000

49%

2004

$1,500,000

48%

2005

$1,500,000

47%

2006

$2,000,000

46%

2007

$2,000,000

45%

2008

$2,000,000

45%

2009

$3,500,000

45%

2010*

$5,000,000 or $0*

35% or 0%*

2011

$5,000,000

35%

2012

$5,120,000

35%

2013

$1,000,000

55%


*Estate of decedents who died during 2010 have the choice of using either the $5,000,000 estate tax exemption/35% estate tax rate or $0 estate tax exemption/0% estate tax rate but they must use special modified carryover basis rules that impact income tax consequences.

So let’s go through an example to show you how this works.  Let’s assume you are single and when you add up your home, bank accounts, retirement accounts, and a life insurance policy, you estimate that your total gross estate is $1.5 million.  Under the current rules, if you were to die in 2012, your estate would not owe any estate taxes because you are under the $5.12 million estate tax exemption.  However, if you were to die in 2013, you would owe $275,000 in estate taxes! 

Here’s what the calculation would look like:

$1,500,000 total estate ˗ $1,000,000 estate tax exemption = $500,000 taxable estate

$500,000 taxable estate × 55% tax rate = $275,000 estate tax liability