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Estate Tax: Unraveling The Myth

Tue Apr 12, 2016 18:38:48PM | Categories: Estate Tax
Pittock Mansion, Portland, OregonBy: Another Believer

The Federal Estate Tax or FET, for short, has been around for literally 100 years. Misinformation has spread rampantly about this tax, mostly by those who call for its repeal; the owners of large estates, you know, the wealthy. They give it the name "Death Tax" and the plebeians begin singing of its horrors in the streets. It isn't the green eyed monster men in the coffee shops talk about in hushed tones, not at all.

One of the reasons why policy makers created the estate tax in 1916 was because the largest estates consist mostly of "unrealized" capital gains that have never been taxed in the first place. This way, the estate tax serves as a sort of backstop to the income tax, taxing the income of the wealthy that would have gone untaxed otherwise. Simply, it's there to tax large inheritances by a small group of wealthy heirs, which is why it is ridiculous to call it "Death Tax." Columnist E. J. Dionne was quoted to have said that an estate tax repeal could then be called, the "Paris Hilton tax cut."

To put it into proper perspective, let's consider the numbers, shall we? Two out of every one thousand estates face the FET. According a CBPP article, the Joint Committee on Taxation stated that 99.8 percent of estates didn't owe an estate tax last year. Only the estates of the .2 percent of Americans owed an estate tax.

If you are wondering how the estate tax is applied, then here is a breakdown of how it works.

First of all, there are many exemptions to consider, depending on what kind of estate someone has, such as a farm or a large complex, but every estate enjoys one particular perk: Unlimited Marital Deduction. It's dead simple (no pun intended). A person can transfer an unlimited amount of money to their spouse. For example, if the husband dies, leaving all assets to his wife, there is no estate tax.

In 2016, someone can transfer up to $5,450,000 to anyone who is not their spouse, such as heirs, and not receive an estate tax. If an estate is appraised at $500,000, and it is the principle asset in the estate, then it will not receive an estate tax.

In January of 2011, another very important change came to the estate tax, and that is Portable Exemption. By law, a person's exemption of $5,450,000 can be transferred to their husband or wife, bringing the total exemption to $10,900,000. In order for the exemption to be transferred, a 706 form must be filled out at death in order to quantify the amount of the exemption that will pass on to the spouse. Otherwise, it does not automatically transfer to the spouse. That means, that the parents can transfer up to $10,900,000 to their heirs.

So let's simplify it into two different situations. We'll call one estate the "poor planning" estate and the other the "good planning" estate.

The Poor Planning Estate:

Estate worth: $15,000,000

Liquid Assets:$1,000,000

The husband dies, leaving the entire estate to his wife under the Unlimited Marital Deduction, resulting in no estate tax. However, she did not file a 706 form, resulting in no portability of his exemption. Some years later, she dies, leaving the estate to her children. Since there wasn't portability of their fathers exemption, the children can only receive $5,450,000 from their mother, making it a taxable estate of $9,550,000. Currently,the estate tax's percentage rate is 40%.

$9,550,000 x 40% = $3,820,000 FET

If the children are able to scrape together their $1 million in assets, that still puts them at $2,820,000 in estate tax.

The Good Planning Estate:

Estate worth: $15,000,000

Liquid Assets:$1,000,000

It is the same situation, but the wife filed a 706 form at the time of her husband's death. She dies, leaving the children the estate with her exemption of $10,900,000, which brings the taxable estate to $4,100,000.

$4,100,000 x 40% = $1,640,000 FET

That's $2,180,000 saved by the Portable Exemption, resulting in the heirs owing $640,000 after liquid assets are applied.

So what do we take away from this? For one, it doesn't apply to the vast majority of Americans as some would want us to think. Two, it's a simple machine on the outside, but once you open it up, it can get pretty greasy.

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