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What Taxes Might an Estate Need to Pay?

Because federal and state tax authorities are much more concerned with how much of the decedent’s property they can tax, they allow for a much broader definition of what the decedent owned at the time of his or her death.

Although the probate estate includes only property in the decedent’s name alone or payable to the estate, for estate tax purposes all property owned by the decedent in any form, including jointly held or in a revocable trust, and any property payable to any person or the probate estate as a result of the decedent’s death, is includible in the taxable estate.

Transfer taxes for an estate

Transfer taxes are taxes on a person’s right to transfer property and are levied on the value of property as it passes from one person to another through gift or inheritance. Although the following taxes go by different names (gift tax, estate tax, and generation-skipping transfer tax), they’re all part of the same umbrella system of taxing the transfer of property.

Some transfers that are not considered taxable gifts include

  • Annual exclusion gifts: Gifts that are limited to the annual exclusion amount. The annual exclusion amount in 2013 is $14,000 per donee and is reviewed annually.

  • Gifts to a spouse: You may give an unlimited amount to your spouse, provided your spouse is a U.S. citizen.

  • Tuition and medical expenses paid for someone else.

  • Gifts to political organizations.

  • Gifts to qualified charities: Qualified charities have obtained tax-exempt status from the IRS.

There is also a lifetime unified credit that can be applied against any gift tax. Any use of this unified credit during life reduces the use of the unified credit against the federal estate tax upon death.

Federal gift tax

The federal gift tax is a tax on the transfer of property from one person (the donor) to another (the donee) with no payment (or less than full payment) in return. Watch it, because the gift tax is triggered whether the person transferring the property intended to make a gift or not!

Federal estate tax

The federal estate tax (sometimes mistakenly referred to as the “death tax”) is a tax on the transfer of property at death. All property the decedent owns or has an interest in at death, in whatever form it’s held, is subject to the tax.

Only about 2 percent of estates are actually subject to the estate tax because of an exemption amount, which is $5.12 million for 2012

Generation-skipping transfer tax

The generation-skipping transfer (GST) tax is a relatively new invention, intended to ensure that the federal government gets its slice of the pie each and every time assets move from one generation to the next.

As a result of more and more people discovering that they may be able to pay less overall transfer tax by bypassing their children and giving property directly to grandchildren (or even better, great-grandchildren), Congress plugged this particular loophole so that the gift tax and estate tax can no longer be evaded at any generational level by skipping a generation on the transfer.

The GST tax doesn’t apply to gifts that aren’t subject to the gift tax.

Note: A transfer of property to a grandchild is normally considered a direct skip and is subject to the GST tax. However, if that grandchild’s parent has already died at the time of the transfer, the transfer is not subject to the GST tax.

State estate, inheritance, and other transfer taxes

State transfer taxes are in a state of flux due to fairly recent changes in federal estate tax law. Until 2005, there was a credit against estate tax due on the federal estate tax return for state death taxes paid, with the limit on the amount of the credit based on the size of the taxable estate. That credit was abolished as of 2005.

Unfortunately, state death taxes paid may now be taken only as a deduction against the amount of the federal taxable estate, and deductions are never worth as much in your pocket as credits.

Overall, slightly less than half of all states currently have an estate or inheritance tax, and there are movements afoot in several states to eliminate the estate or inheritance tax.

Other taxes

No, you’re not out of the tax woods yet, but at least these taxes should be somewhat more familiar to you from your personal tax life.

  • Federal income tax for decedent and estate: You must prepare and file the decedent’s final federal income tax return, as well as an income tax return for the estate for every year it’s in existence. The estate income tax return does have some differences from the individual return.

  • State income tax for decedent and estate: If the decedent was domiciled (had his or her legal place of residence) in a state that has an income tax, you must also prepare and file a final state income tax return for the decedent and an estate state income tax return for each year the estate is in existence.

  • State intangibles tax: If your decedent was domiciled in a state which has an intangibles tax (a tax on certain intangible assets owned by the decedent, such as stocks and bonds), and if he or she had assets subject to the tax, you must prepare and file the final intangibles tax return for the decedent, as well as returns for the estate (if required).

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