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What happens when the inevitable taxes and death intersect? As you might suspect, the first order of business is to determine if the final estate owes any taxes.
So just what is an estate? Basically, it is everything you own: your home and other real estate, bank accounts, investments, retirement benefits from your employer, IRAs, insurance policies, collectibles and personal belongings. Add these assets, then subtract your debts to arrive at the estate’s value.
Depending on how much you own when you die, your estate may have to pay estate taxes before your assets can be fully distributed. Estate taxes are different from, and in addition to, probate expenses and final income taxes owed on income you receive in the year you die.
The federal estate tax is technically a tax on the transfer of property to others, generally to children of a decedent (a person who died). It was envisioned to prevent families from passing on huge fortunes and developing a type of royalty in America. The tax is levied on the deceased’s estate as a whole, filed on a single estate tax return and paid out of the estate’s funds.
Federal estate taxes were first collected in 1916. They are being phased out under 2001 tax legislation, with the estate tax set to expire completely in 2010. In the meantime, the taxes can still add up against large estates. But they can be reduced or eliminated — if you plan ahead.
Your estate will have to pay taxes if its net value when you die is more than the “exempt” amount set by Congress. The table below shows the current exemption schedule and the tax rate applied to property over that amount. If lawmakers do not permanently repeal estate taxes after 2010, the exemption amount returns to $1 million in 2011.
|Year of death
|Federal estate tax exemption
|Highest rate on “excess” property
|2002 and 2003
|50% in 2002;
49% in 2003;
|2004 and 2005
|48% in 2004;
47% in 2005;
|2006, 2007 and 2008
|46% in 2006;
45% in 2007 and 2008
Estate taxes are separate from inheritance taxes. The U.S. government imposes no inheritance tax. Some states, however, do levy both inheritance and estate taxes.
State-level estate taxes usually are in the form of a “sponge tax” that piggybacks on the federal estate tax. The federal estate tax allows each estate a tax credit for any state in which inheritance or estate taxes are paid, up to a maximum dollar amount.
States also might impose an inheritance tax on beneficiaries who receive property from the deceased. These taxes are assessed by states in place of or in addition to state and federal estate taxes. The tax is calculated separately for each beneficiary, and each beneficiary is responsible for paying his or her own inheritance taxes.
Bankrate’s state tax directory has details on various state inheritance and estate tax laws. Where such taxes are collected, spouses and children of the deceased often are exempted or taxed at lower rates than other heirs.
You can specify in your will that you want your estate to pay any inheritance taxes that the government may slap on your heirs. It’s a nice gesture, and may even keep your heirs from being forced to sell property you leave them in order to pay taxes.
Filing the final form
A personal representative must file certain tax returns for a decedent and the decedent’s estate, both on the state and federal levels. The personal representative may be required to file the final income tax return of the decedent and any returns not filed for preceding years; the U.S. income tax return for estates and trusts; and the United States estate tax return.
At the federal tax level, the person who is filing a return for a decedent and claiming a refund must file Form 1310 along with a copy of the death certificate. If you’re a surviving spouse filing a joint return or a court appointed or certified personal representative, you don’t need to file Form 1310.