Taxes incurred after death can be quite costly. For example, Helen Walton received $5.1 billion in stock at the death of her husband Sam Walton (founder of Wal-Mart Stores). At this value, these shares could eventually cost her heirs as much as $2.8 billion in taxes at her death- $2.2 billion to the U.S. government and $640 million to the State of Arkansas.”

Historically, estate taxes have been used as a method for redistributing wealth and raising revenues. According to tax experts, in 2006, estate taxes raised $28.0 billion in net revenue. This total amounted to 1.14 percent of all tax money generated by the federal government in that year.

The budget surpluses that appeared in the latter part of the 1990s began to cast doubts on the continued need for a federal estate tax. Many arguments can be made both for this tax (to some there is a perceived limit to the amount that a beneficiary should receive without work or effort) and against it (income that has been taxed once when earned should not be taxed again when the resulting assets are conveyed at death).

In 1999 (and again in 2000), the U.S. Congress voted a phased-in repeal of the estate tax, a measure that then President Bill Clinton vetoed as being too costly. However, in 2001, Congress passed the Economic Growth and Tax Relief Reconciliation Act of 2001, which included provisions to gradually reduce and then abolish this tax by 2010. President George W. Bush signed the measure into law.


Estate planning, however, is still very difficult because the estate tax is scheduled to reap­pear in 2011 unless Congress moves to make the repeal permanent in the interim. “Because fewer than 60 senators voted for the tax bill on May 26, 2001 (58 for to 33 against), the Byrd rule applies. The net effect of that rule is that, unless Congress votes to permanently extend the estate tax repeal, it applies only in year 2010.”

Without being able to anticipate the exact laws that will apply at the date of a future death, estate planning becomes uncertain at best. Unless the repeal is extended, the financial impact of dying on January 1, 2011, rather than on December 31, 2010, could be catastrophic for a large estate.

Furthermore, the large budget deficits that began to appear early in the 21st century brought the entire Economic Growth and Tax Relief Reconciliation Act back into the political debate. Some argued that the implementation of its wide-ranging provisions should be made permanent or even escalated to stimulate the economy.

Others suggested the benefits should be deferred or repealed completely to help increase tax revenues and reduce budget deficits. Whether the estate tax is permanently abolished or reappears in 2011 is almost impossible to predict. As one observer wrote early in 2002, “There will be two presidential elections and four congressional elections by 2011. No one can predict accurately the future political climate.”


The ongoing debate over the eventual abolition of this tax will have a major impact on estate planning. Prior to passage of this legislation, the tax was as high as 55 percent, with an added 5 percent surcharge on large estates. Consequently, most individuals who were subject to the tax were willing to spend significant amounts to reduce the eventual burden.

However, for the next few years, during the phase-out period, estates of a substantial size will still be subject to a federal estate tax although at a lower rate. Estate planning will undoubtedly con­tinue as an important issue at least during this period.

The new law has no impact on the payment of state inheritance taxes because states have their own estate tax structures. In the past, the federal government allowed a limited credit for such taxes assessed by the state. Within certain parameters, amounts paid to a state could be used to reduce assessments that were due to the federal government. For 2002 through 2004, however, this credit was reduced significantly and then changed to a deduction (a decrease in the size of the estate).

Federal Estate Taxes:


The federal estate tax is an excise tax assessed on the right to convey property. The computa­tion begins by determining the fair value of all property held at death. Therefore, even if real property is transferred immediately to the beneficiary and is not subject to probate, the value must still be included for federal estate tax purposes.

In establishing fair value, the executor may choose an alternate valuation date if that decision will reduce the amount of estate taxes to be paid. This date is six months after death (or the date of disposition for any property dis­posed of within six months after death). Thus, the federal estate tax process starts by deter­mining all asset values at death or this alternate date. Note that a piecemeal valuation cannot be made; one of these dates must be used for all properties.

Several items then reduce the gross estate figure to arrive at the taxable value of the estate:

i. Funeral expenses.


ii. Estate administration expenses.

iii. Liabilities.

iv. Casualties and thefts during the administration of estate.

v. Charitable bequests.


vi. Marital deduction for property conveyed to spouse.

vii. State inheritance taxes.

Individuals are allowed to deduct a specified amount from the value of the estate in arriv­ing at the federal estate tax. Recent tax legislation has escalated the portion of an estate that is exempted. Any remaining amount is taxed at graduated rates based on the year of death.

In the past, individuals have often sought to decrease the size of their estates to reduce estate taxes by making gifts during their lifetimes. Annual gifts of $12,000 per person (an amount that is indexed to change with inflation) can be made tax free to an unlimited number of donees.


The federal gift tax has not been eliminated by the new tax legislation, but a $1 million lifetime tax-free exclusion has now been established over and above the $12,000 exclusion per person per year. Furthermore, instead of having a separate tax rate schedule as in the past, the maximum gift tax rate eventually will be the same as the maximum individual income tax rate.

Federal Estate Taxes—Example 1:

The determination of the taxable estate is obviously an important step in calculating estate taxes. Assume for illustration purposes that a person dies holding assets valued at $4 million and has total debts of $400,000 at death. Funeral expenses cost $20,000, and estate administration expenses amount to $40,000. This person’s will left $300,000 to charitable organizations, and the remaining $3,240,000 (after debts and expenses) goes to the surviving spouse.


Under this set of circumstances, no taxable estate exists:

Federal Estate Taxes—Example 2:

Because of the current exemptions, a limited amount of estate property ($2.0 million in 2006, 2007, and 2008, and $3.5 million in 2009) can be con­veyed tax free to a beneficiary other than a spouse. The ability to shelter this amount of assets from tax has an important impact on estate planning. For example, in the preceding case, if the couple has already identified the recipient of the estate at the eventual death of the second spouse (their children, for example), a conveyance of the tax-free exclusion amount at the time of the first death is usually advantageous.

The second estate will then be smaller for subse­quent taxation purposes. Frequently, individuals establish a trust fund for this purpose as a means of protecting their money and ensuring its proper distribution.

To illustrate, assume that the first spouse died in 2007. Assume also that the will that is written is identical to the preceding example except that only $1,240,000 is conveyed to the surviving spouse and the remaining $2 million is placed in a trust fund for the couple’s children (a nondeductible amount for estate tax purposes).


The estate tax return must now be adjusted to appear as follows:

Again, the estate pays no taxes, but only $1,240,000 is added to the surviving spouse’s taxable estate rather than $3,240,000. Thus, an eventual decrease in the couple’s total estate taxes of $780,800 has been established.

However, this strategy may not work for couples unless the title to their assets is properly designated. This illustrates a situation in which the success of estate planning can hinge on a proper understanding of how the laws function.

Legally, if a couple holds property as joint tenants or tenants by the entirety, the property passes automatically to the survivor at the death of the other party. Thus, if all property were held in one of these ways, the decedent would have no estate and would not be able to experi­ence the benefit of the tax-free amount. However, if property is held by the couple as tenants in common, the portion the decedent owned is included in that person’s estate and, up to the set limit, can be conveyed tax free to a non-spouse beneficiary.

Other Approaches to Reducing Estate Taxes One technique previously used by families with large fortunes to reduce estate taxes was to transfer assets to grandchildren and even great-grandchildren. This manner reduced the number of separate conveyances (each of which would have been subject to taxation at the top rate) from parent to child to grandchild.

However, the government effectively eliminated the appeal of this option by establishing a generation-skipping transfer tax. Under this law, after an exemption, a flat tax was assessed on transfers by gift, bequest, or trust distribution to individuals two or more generations younger than the donors or decedents. (However, the exemption was unlimited for a transfer to a grandchild when the grandchild’s parent was deceased and she was a lineal descendent of the transferor.)

More recently, with its passage of the Economic Growth and Tax Relief Reconciliation Act of 2001, Congress began to phase out the generation-skipping transfer tax. Without an estate tax, no justification exists for a generation-skipping tax. The exemptions and the high­est tax rates will follow the same changes shown earlier for the federal estate tax so that com­plete repeal will occur in 2010. Of course, in the interim, individuals can also take advantage of the $1 million lifetime exemption for gifts as well as the annual $12,000 per donee gift tax exclusion.

State Inheritance Taxes:

States assess inheritance taxes on the right to receive property with the levy and all other reg­ulations varying, based on state laws. However, the specifications of a will determine the actual impact on the individual beneficiaries. Many wills dictate that all inheritance tax payments are to be made from any residual cash amounts that the estate holds. Consequently, individuals receiving residual legacies are forced to bear the entire burden of this tax.

If the will makes no provisions for state inheritance taxes (or if the decedent dies intestate), the amounts conveyed to each party must be reduced proportionately based on the fair value received. Thus, the recipient of land valued at $200,000 would have to contribute twice as much for inheritance taxes as a beneficiary collecting cash of $100,000. Decreasing a cash legacy to cover the cost of inheritance taxes creates little problem for the executor.

However, a direct reduction of an estate asset such as land, buildings, or corporate stocks might be virtu­ally impossible. Normally, the beneficiary in such cases is required to pay enough cash to sat­isfy the applicable inheritance tax. The estate planning process often establishes life insurance policies to provide cash for such payments.

Estate and Trust Income Taxes:

Although all estates require time to be settled, the period can become quite lengthy if com­plex matters arise. From the date of death until ultimate resolution, an estate is viewed legally as a taxable entity and must file a federal tax return if gross income is $600 or more. The return is due by the 15th day of the fourth month following the close of the estate’s taxable year. The calendar year or any other fiscal year may be chosen as the taxable year. In 2005, nearly 3.7 million estate and trust income tax returns were filed with the Internal Revenue Service.

Applicable income tax rules for estates and trusts are generally the same as for individual taxpayers. Therefore, dividend, rental, interest, and other income earned by an estate in the period following death is taxable to the estate unless the income is of a type that is specifically nontaxable (such as municipal bond interest).

A $600 personal exemption is provided as a decrease to the taxable balance. In addition, a reduction is allowed for-(1) any taxable income donated to charity and (2) any taxable income for the year distributed to a beneficiary. In 2007, federal tax rates were 15 percent on the first $2,150 of taxable income per year with various rates levied on any excess income earned up to $10,450. At a taxable income level more than $10,450, a 35 percent rate is incurred.

As an illustration, assume that in 2007 an estate earned net rental income of $30,000 and dividend income of $8,000. The dividend income was distributed immediately to a beneficiary and was taxable income for that individual, and $6,000 of the rental income was given to char­ity.

Estate income taxes for the year would be computed as follows: