Inheritance tax

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Inheritance tax, also known in some countries outside the United States as a death duty and referred to as an estate tax within the U.S, is a form of tax imposed upon the transfer of the property of the estate of a deceased person that is left to a living person or organisation.

Supporters of the inheritance tax argue that it is not a death tax per se, but simply a tax on a transfer of wealth. Opponents argue that the tax is applied to the full estate, and not merely the amount transferred, which arguably increases the effective transfer tax rate. In the United States, the tax is imposed only on the "taxable estate," which is generally less than the value of the full estate.

If an asset is left to a spouse or a charitable organization, some countries do not apply the tax. The tax is also imposed on other transfers of property made as an incident of the death of the owner, such as a transfer of property from an intestate estate or trust, or the payment of certain life insurance benefits or financial account sums to beneficiaries.

For UK Inheritance tax, see Inheritance Tax (United Kingdom).

1 United States
2 Further reading
3 External links

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United States

In the United States, estate and/or inheritance taxes may be imposed at both the national (Federal) level and the state level.

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Federal estate tax

The Federal estate tax is imposed "on the transfer of the taxable estate of every decedent who is a citizen or resident of the United States." See Template:Usc.

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The "gross estate"

The "gross estate" for Federal estate tax purposes often includes more property than that included in the "probate estate" under the property laws of the state in which the decedent lived at the time of death. The starting point for the calculation of the estate tax is the value of the "gross estate" defined at Template:Usc and Template:Usc, as modified by certain other statutory provisions. The gross estate (before the modifications) may be considered to be the value of all the property interests of the decedent at the time of death. To these interests are added the following property interests generally not owned by the decedent at the time of death:

the value of property to the extent of an interest held by the surviving spouse as a "dower or curtesy" (see Template:Usc);

the value of certain items of property in which the decedent had, at any time, made a transfer during the three years immediately preceding the date of death (i.e., even if the property was no longer owned by the decedent on the date of death), other than certain gifts, and other than property sold for full value (see Template:Usc);

the value of certain property transferred by the decedent before death for which the decedent retained a "life estate," or retained certain "powers" (see Template:Usc);

the value of certain property in which the recipient could, through ownership, have possession or enjoyment only by surviving the decedent (see Template:Usc);

the value of certain property in which the decedent retained a "reversionary interest," the value of which exceeded five percent of the value of the property (see Template:Usc);

the value of certain property transferred by the debtor before death where the transfer was revocable (see Template:Usc);

the value of certain annuities (see Template:Usc);

the value of certain jointly owned property (see Template:Usc);

the value of certain "powers of appointment" (see Template:Usc);

the amount of proceeds of certain life insurance policies (see Template:Usc).

The above list of modifications is not comprehensive.

As noted above, life insurance benefits may be included in the gross estate (even though the proceeds arguably were not "owned" by the decedent and were never received by the decedent). Life insurance proceeds are generally included in the gross estate if the benefits are payable to the estate, or if the decedent was the owner of the life insurance policy or had any "incidents of ownership" over the life insurance policy (such as the power to change the beneficiary designation). Similarly, bank accounts or other financial instruments which are "payable on death" or "transfer on death" are usually included in the taxable estate, even though such assets are not subject to the probate process under state law.

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Deductions, the taxable estate, and the tentative tax

Once the value of the "gross estate" is determined, the law provides for various "deductions" (in Part IV of Subchapter A of Chapter 11 of Subtitle B of the Internal Revenue Code) in arriving at the value of the "taxable estate." Deductions include but are not limited to:

Funeral expenses, administration expenses, and claims against the estate (see Template:Usc);

Certain charitable contributions (see Template:Usc);

Certain items of property left to the surviving spouse (see Template:Usc).

After subtracting the deduction amounts from the gross estate amount to arrive at the "taxable estate" amount, the tax rate is imposed on the value of the "taxable estate" to compute the tentative tax.

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Tax credit, the exemption equivalent, and the tax

However, the law then provides for a credit against the tentative tax. The credit may be thought of as providing, in effect, for an "exemption equivalent" or exempted value with respect to the value of the property. For a person dying during 2005, an estate with a value less than $1,500,000 would not pay a federal estate tax and most likely would not have to file a federal estate tax return. The applicable exclusion amount increases to $2,000,000 for decedents dying in the years 2006, 2007 and 2008. The amount increases to $3,500,000 for 2009. According to the Econonic Growth and Tax Relief Reconciliation Act of 2001, the federal estate tax disappears for the year 2010, but the tax returns in 2011 at the 2001 level.

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Requirements for filing return and paying tax

For estates larger than the current federally exempted amount, any estate tax due is paid by the executor or other person responsible for administering the estate. That person is also responsible for filing a Form 706 return with the Internal Revenue Service. The return must contain detailed information as to the valuations of the estate assets and the exemptions claimed, to ensure that the correct amount of tax is paid.

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Criticisms of the Federal estate tax

Many of its opponents refer to the estate tax as the "death tax" and have called for its abolition. Since 2003, the top rate has dropped from 50% by one percent per year; it is scheduled to drop to 45% in 2009, thence to 0% in 2010, but as of 2006, if no further changes in the law are enacted, the tax will be reimposed at a top rate of 50% in 2011. It is possible, however, that Congress could act in the interim and extend the abolition of the estate tax indefinitely, and legislation has been introduced to this effect.

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Exemptions and tax rates

As noted above, a certain amount of each estate is exempted from taxation by the federal government. Below is a table of the amount of exemption by year an estate would expect. Estates above these amounts would be subject to estate tax, but only for the amount above the exemption.

For example, assume an estate of $3.5 million in 2005. There are two beneficiaries who will each receive equal shares of the estate. The maximum allowable credit is $1.5 million for that year, so the taxable value is therefore $2 million. Since it is 2005, the tax rate on that $2 million is 47%, so the total taxes paid would be $940,000. Each beneficiary will receive $750,000 of untaxed inheritance and $530,000 from the taxable portion of their inheritance for a total of $1,280,000. This means that they would have paid (or, more precisely, the estate would have paid) a taxable rate of 26.9%.

Year	Max. Estate Tax Credit	Marginal Tax Rate
Year	Max. Estate Tax Credit	Marginal Tax Rate
2002	$1 million	50%
2003	$1 million	49%
2004	$1.5 million	48%
2005	$1.5 million	47%
2006	$2 million	46%
2007	$2 million	45%
2008	$2 million	45%
2009	$3.5 million	45%
2010	repealed	N/A
2011	reinstated at 2002 level	N/A

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Inheritance tax at the state level

Many U.S. states also impose their own estate or inheritance taxes (see Ohio estate tax for an example). Some states "piggyback" on the federal estate tax law in regard to estates subject to tax (i.e., if the estate is exempt from federal taxation, it is also exempt from state taxation). Some states' estate taxes, however, operate independently of federal law, so it is possible for an estate to be subject to state tax while exempt from federal tax.

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Debate

The propriety of the estate tax has been debated extensively. Opponents argue that the Federal estate tax rate is effectively higher as a percentage of the amount actually transferred to heirs. For example, an estate worth $3.5 million paid $940,000 federal estate tax in order to transfer $1,280,000 to each heir, suggesting an effective transfer tax rate of 36.7%. Similarly, at the limit, the top federal tax rate of 50% on the estate value would imply a transfer tax rate of 100% of the amount transferred to heirs. The high effective transfer tax rate has prompted many wealthy benefactors to make sizable gifts during their lifetime, paying a gift tax on the amount transferred, rather than allow the whole amount to be taxed at the estate level.

Some argue that the estate tax creates a potential for double taxation, that is, taxation on assets which have already been taxed. Double taxation occurs on earned income, but not the unrealized capital appreciation of houses, farms, stocks, bonds, real estate, and collectibles such as works of art. FactCheck.org cites a 2000 study of 1998 estate taxation, which determined that unrealized capital gains made up 36.3% of the value of all estates in 1998, and 56.4% of estates worth more than $10 million (but without taking into account yearly increases of inflation).

The debate sometimes revolves around which estates are affected by current law. The effects of the law on small business owners and family-owned farms (entities which, conservatives argue, are hardest hit by the estate tax) was studied in an analysis undertaken by the Tax Policy Center. A study of the 18,800 taxable estates taxed in 2004 found 7,090 which had any farm or business income. Of those, there were 440 estates in which half or more of its assets were the value of farms and/or businesses. The effective tax rate on the 440 estates studied in detail never averaged more than 23%.

Proponents of the estate tax argue that it serves to prevent the perpetuation of wealth, free of tax, in wealthy families and that it is necessary to a system of progressive taxation. Proponents point out that the estate tax only affects estates of considerable size and provides numerous credits (including the unified credit) that allow a significant portion of even large estates to escape taxation. Regarding the tax's effect on farmers, proponents counter that this criticism is misguided as there is an exemption built into the law that is specifically designed for family-owned farms. (According to the Center on Budget and Policy Priorities, "The American Farm Bureau Federation acknowledged to the New York Times that it could not cite a single example of a farm having to be sold to pay estate taxes." [1].)

Estate value	Number of returns	Average tax (in thousands)	Effective tax rate
Estate value	Number of returns	Average tax (in thousands)	Effective tax rate
< $1 million	0	$0	0.0%
$1 - $2 million	190	$26	1.6%
$2 - $3.5 million	60	$190	7.5%
$3.5 - $5 million	40	$449	12.0%
$5 - $10 million	80	$1,322	19.3%
$10 - $20 million	50	$2,832	22.9%
> $20 million	30	$23,442	22.2%
All	440	$2,238	19.9%

Furthermore, supporters argue that many large fortunes do not represent taxed income or savings, that wealth is not being taxed but merely the transfer of that wealth, and that many large fortunes represent unrealized capital gains which with a step up in basis, will never be taxed as capital gains under the federal income tax. Some even go further and suggest all transfers should be taxed, and that the large bequests to family foundations or private charities should be taxed and more heavily regulated.

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Related taxes

The US also imposes a gift tax, assessed in a manner similar to the estate tax. One obvious purpose is to prevent a person from easily avoiding paying estate tax by giving away all of their assets during their lifetime. However, an exemption is available for transfers of up to $12,000 per person per year (beginning in 2006). A single donor can make gifts up to this amount to as many people as they wish each year, so if they have enough people they wish to give assets to and/or enough time, they may be able to reduce their estate enough to avoid estate tax.

Furthermore, transfers (whether by bequest, gift, or inheritance) in excess of $1 million may be subject to a generation-skipping transfer tax if certain other criteria are met.

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