Definition
The estate tax is a government levy imposed on the fair market value of property transferred from a deceased individual to their heirs. The valuation includes all assets owned by the decedent at the time of death, such as real estate, personal property, financial investments, and business interests, minus any debts and liabilities. Relevant laws, including the federal estate tax and gift tax, have been unified to apply one credit amount to the total lifetime and death-time property transfer.
Examples
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Individual Estate: Suppose a decedent leaves behind property worth $5 million with no liabilities. The government’s estate tax would be calculated based on this $5 million value, minus any applicable exemptions and credits.
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Combined Estate and Gift: An individual gifts $2 million during their lifetime and leaves $4 million of property upon death. The unified federal estate and gift tax credit will be applied to the sum of $6 million.
FAQs
What is the difference between estate tax and inheritance tax?
- Estate Tax: Levied on the deceased’s estate before distribution to heirs.
- Inheritance Tax: Imposed on the beneficiaries receiving the assets.
Does every estate have to pay the estate tax?
No, estate tax is only applicable if the value of the estate exceeds federal and/or state exemption thresholds.
How is the estate tax calculated?
Estate tax is calculated based on the fair market value of the estate at death, minus any liabilities, exemptions, and applicable credits.
What are common exemptions and deductions in estate tax?
Common exemptions include the marital deduction (property passed to a surviving spouse), charitable deductions, and a federal exemption amount which may vary year-to-year.
Who is responsible for paying the estate tax?
The executor or administrator of the estate is responsible for filing the estate tax return and paying any due taxes from the estate’s assets.
- Fair Market Value: The price at which an asset would sell in an open and competitive market.
- Federal Estate Tax: A tax imposed by the federal government on the transfer of the taxable estate of a deceased person.
- Gift Tax: A tax on transferring property by one individual to another while receiving nothing, or less than fair market value, in return.
- Unified Credit: A tax credit that reduces or eliminates the estate tax or gift tax for an individual.
References
Suggested Books
- “Estate and Trust Administration For Dummies” by Margaret Atkins Munro
- “Make Your Own Living Trust” by Denis Clifford
- “Estate Planning Basics” by Denis Clifford
Fundamentals of Estate Tax: Taxation Basics Quiz
### What does the estate tax apply to?
- [x] The fair market value of a deceased person's property at death
- [ ] The book value of the property
- [ ] Only liquid assets at death
- [ ] Future expected earnings of the deceased
> **Explanation:** The estate tax applies to the fair market value of a deceased person's property at death, which includes all assets at the current market price minus liabilities.
### What types of property are included in the taxable estate?
- [x] Real estate, personal possessions, financial investments, and business interests
- [ ] Only real estate
- [ ] Only financial investments
- [ ] Only personal possessions
> **Explanation:** The taxable estate includes all property owned by the decedent, such as real estate, personal possessions, financial investments, and business interests.
### What is the unified credit?
- [ ] A tax credit applied only to gift taxes
- [ ] A deduction available for charitable donations
- [x] A credit that reduces estate and gift taxes for an individual
- [ ] A rebate for timely tax payments
> **Explanation:** The unified credit is a credit that reduces or eliminates estate and gift taxes for an individual, combining the concepts of both.
### Who files the estate tax return?
- [ ] The estate lawyer
- [ ] The primary heir
- [x] The executor or administrator of the estate
- [ ] The probate court
> **Explanation:** The executor or administrator of the estate is responsible for filing the estate tax return and ensuring that any taxes due are paid.
### Which of the following reduces the taxable estate?
- [x] Marital deductions
- [ ] Property appraisals
- [ ] Liability reassessment
- [ ] Real estate depreciation
> **Explanation:** Marital deductions (property passed to a surviving spouse) and charitable deductions are common ways to reduce the taxable estate.
### What determines the fair market value of an estate's property?
- [ ] The property's purchase price
- [x] A competitive market assessment
- [ ] Local property taxes
- [ ] Original owner's appraisal
> **Explanation:** Fair market value is determined by what a willing buyer would pay in an open, competitive market.
### Can estate taxes be contested?
- [ ] No, they are final.
- [ ] Yes, but only if the estate is under $1 million.
- [x] Yes, though it generally requires a professional assessment or legal challenge.
- [ ] Yes, and it can be done independently without any assessment.
> **Explanation:** Estate taxes can be contested through professional assessments or legal challenges if there is a disagreement with the IRS's valuation or assessment.
### What is one significant benefit of using the marital deduction in estate planning?
- [x] It allows for unlimited property transfers to a surviving spouse free of estate tax.
- [ ] It provides a 50% tax deduction on transferred property.
- [ ] It exempts the entire estate from taxes.
- [ ] It simplifies the probate process.
> **Explanation:** The marital deduction allows for unlimited property transfers to a surviving spouse free of estate tax, effectively deferring taxation until the death of the surviving spouse.
### Which tax is combined with the estate tax under the unified system?
- [ ] Sales tax
- [ ] Income tax
- [x] Gift tax
- [ ] Property tax
> **Explanation:** The federal estate tax and gift tax have been combined under a unified system, allowing one credit amount to apply to the transfer of property both during life and at death.
### How often do the exemption thresholds for federal estate tax change?
- [ ] Annually
- [x] They can vary, but changes are determined by legislative updates or inflation adjustments.
- [ ] Never
- [ ] Every ten years
> **Explanation:** Federal estate tax exemption thresholds can change based on legislative updates or inflation adjustments, potentially varying year-to-year.
Thank you for embarking on this journey through our comprehensive taxation lexicon and tackling our challenging sample exam quiz questions. Keep striving for excellence in your financial knowledge!
