Everyone talks about the Estate Tax and how evil it is, even causing financial disasters within very wealthy circles, but few know how it is actually calculated. So today, I am going to show you you how to easily calculate the Federal Estate Tax. I say Federal because there are certain states with estate taxes, but the amounted collected on the State level is dwarfed by the revenue collected by the Federal Government.
Is the math going to be perfect? Nope. Rather, I am going to be using what is commonly referred to as “napkin math” round numbers to make it easier for all of us (hey, its not like we are going to be filling out a 706 Form after this post…hopefully).
Calculating the Federal Estate Tax
The first number we need is the Gross Estate. According to the IRS:
“The Gross Estate of the decedent consists of an accounting of everything you own or have certain interests in at the date of death (Refer to Form 706 (PDF)). The fair market value of these items is used, not necessarily what you paid for them or what their values were when you acquired them. The total of all of these items is your “Gross Estate.” The includible property may consist of cash and securities, real estate, insurance, trusts, annuities, business interests and other assets. Keep in mind that the Gross Estate will likely include non-probate as well as probate property.”
Please take special note of this last point – it doesn’t matter if the property is subject to probate. As an example, a Revocable Living Trust will not, in and of itself, absolve you of paying Federal Estate Taxes. Lastly, there are additional assets which are uncommon in most situations, but may also be included in your gross estate.
What Assets Aren’t Included in the Gross Estate?
Generally, the Gross Estate does not include property owned solely by the decedent’s spouse or other individuals. Gifts received over one’s lifetime are generally not included in the Gross Estate, but taxable gifts are used. Life estates, which represents ownership over land that expires after one’s death, are not included.
Basically, if you own it, control it, or have the power to control it - its included in your gross estate (or half if you own it jointly). Now that we have the gross estate we get to take some deductions.
What Deductions are Available to Reduce the Estate Tax?
Luckily, the IRS provides us with 5 easy deductions:
- Marital Deduction: One of the primary deductions for married decedents is the Marital Deduction. All property that is included in the gross estate and passes to the surviving spouse is eligible for the marital deduction. The property must pass “outright.” In some cases, certain life estates also qualify for the marital deduction.
- Charitable Deduction: If the decedent leaves property to a qualifying charity, it is deductible from the gross estate.
- Mortgages and Debt.
- Administration expenses of the estate.
- Losses during estate administration.
Alright so we have:
- Gross Estate – Deductions = Taxable Estate
The last thing we need to do is take the taxable estate and subtract out the credit shelter amount. The credit shelter amount is the amount that the government says you are allowed to pass to a Non-Spouse U.S. Citizen (remember that it’s unlimited what you can pass on to your spouse). This year, that number is unlimited for non-spouses! But it comes back with a vengeance in 2011 at $1,000,000.
After we take that number off the Taxable Estate we are going to multiply it by the tax rate and we have calculated our federal estate tax. Next year’s rate will be 55%.
We have Mr. Widow who owns $5,000,000 worth of assets in his name in tax year 2011 when he dies. He has no spouse (hence the name) and is going to leave everything to his only son, Evan (sweet, $5 million!).
- Gross Estate: $5,000,000
- Zero Deductions
- Taxable Estate: $5,000,000
- Credit Shelter Amount: $1,000,000
- Taxable amount of $4,000,000 X tax rate of 55%
- Tax owed: $2,200,000
Is this completely accurate? Of course not, but in reality, you’d be surprised at how close this back of the napkin math is!
What do you think of the federal estate tax? Have you ever had to deal with this issue?
(photo credit: Shutterstock)