The estate tax-also known as the “death tax”-is often misunderstood. Despite its prominent place in the political debate over tax policies, the estate tax only affects a small number of estates each year. According to Internal Revenue Service records, there were 4,588 estate tax returns filed nationwide in 2011, including 806 estates in California. That represents an infinitesimal fraction of the estimated 233,000 annual deaths in the state.
Nonetheless, it’s still useful to understand when and how the estate tax applies. Unlike the federal income tax we’re all familiar with, the estate tax is a levy against the property of a deceased individual. The assessment is based on the gross estate of the decedent’s property as of the day of his or her death. (If the decedent’s property earned any income after death, a separate income tax return must be filed by the estate.) The executor or personal representative of the decedent’s estate is responsible for assessing the date-of-death value of all property and, if necessary, reporting it on the federal estate tax return.
Probate Estate vs. Gross Estate
It’s important to note that the gross estate for estate tax purposes is not necessarily the same as the probate estate under California law. The probate estate only includes property disposed of by the decedent’s last will and testament (or under California intestacy law if there is no valid will). This often excludes property the decedent either held jointly with other individuals or property automatically transferred upon death. For example, if you and your spouse have a joint checking account, then the surviving spouse automatically becomes the sole owner upon the other spouse’s death. The account itself will not be part of your probate estate, but it may be part of your gross estate for estate tax purposes.
As noted above, the executor of the estate must determine the date-of-death value for all property in the gross estate. In the case of real estate, a professional appraiser must be hired to make that assessment. Some items, like checking accounts, can be valued simply by reviewing bank statements. For assets that fluctuate in value like stocks, the IRS sets forth rules governing date-of-death appraisals. In some cases an estate may elect alternate valuation, which means the assets are valued six months after the decedent’s death rather than the day of death. This can reduce the value of the gross estate and thus the tax owed.
Deductions and Exemptions
Once the gross estate is determined the executor may then claim various deductions to reduce the taxable amount of the estate. This includes any debts owed by the decedent, funeral and other estate administration expenses, outstanding mortgages on property and any property bequeathed to a surviving spouse. This last item is known as the marital deduction. It allows an unlimited transfer of property from one spouse to the other. (Special rules apply if the surviving spouse is not a United States citizen.)
On top of deductions, federal law exempts a certain portion of all estates from taxation. This amount changes frequently at the whims of Congress. For persons who die in 2013, the first $5.25 million of their estates is exempt. The current maximum tax on any amount over the exemption is 40%. Some states also assess their own estate tax. California phased out its estate tax in 2005.
Even if you don’t expect to leave a multi-million dollar estate to your heirs, it’s still important to understand how the estate tax may affect your ongoing estate planning needs. This article provides just a brief overview of the estate tax process. It’s important to consult with a qualified California estate planning attorney who can advise you on the constantly changing estate tax rules. Contact the Law Office of Scott C. Soady at 1-858-618-5510 if you have any questions.