Federal Estate Tax

Gift & Estate Planning Concepts: Federal Estate Tax

At a Glance

Charitable bequests, or property transferred by will, remain one the most popular means of giving to nonprofit organizations. Estate owners remember charitable organizations in their wills to further both some benevolent ambition as well as to reduce estate tax liability.

A donor failing to use estate planning tools (or failing to make a will) could lose thousands of dollars in estate taxes to the federal government. As an example, Elvis Presley's estate lost 73% of its assets to taxes, leaving only $2.8 million of his $10.2 million estate to his beneficiaries.

The federal estate tax began prior to the twentieth century as a temporary tax imposed during times of war to provide the government with emergency funds. However, the estate tax enacted during World War I became a permanent fixture in the American taxation system. Changes made by the American Taxpayer Relief Act of 2012 brought much needed permanence to the law, while the Tax Cuts and Jobs Act of 2017 increased the estate tax exclusion to $10 million (indexed). However, many of the Tax Cuts and Jobs Act changes are scheduled to "sunset" (the legislative term for expire) at the end of 2025 if Congress doesn't take action to extend them or make them permanent.

Click here for a graphic on how the federal estate tax works.

What's Included in the Gross Estate

At a Glance

Determining estate tax liability begins with calculating a decedent's gross estate. A decedent's gross estate generally includes the value of all property a decedent owns and controls at death. This sounds simple enough, but consider these examples:

$image\bullet.jpg$ Decedent owned a home with his wife as joint tenants

$image\bullet.jpg$ Decedent was the insured under a life insurance policy owned by his daughter

$image\bullet.jpg$ Decedent owned an annuity contract purchased by his employer

Could you easily determine which interest falls within the decedent's gross estate?

Property may be included in the decedent's gross estate under any of several provisions:

Property in Which The Decedent Had An Interest

Generally, all property, whether real or personal, intangible or tangible, goes into the decedent's gross estate under IRC Sec. 2033 if:

$image\bullet.jpg$ The decedent had an interest in the property at death, and

$image\bullet.jpg$ The interest in the property passes to another person by reason of the decedent's death.

Property Owned Outright

To be included in a decedent's gross estate under IRC Sec. 2033, the property must be owned outright by the decedent, meaning the decedent can transfer the property at death. A life estate, an estate lasting for the life of the holder or another person, generally does not transfer property at death, but rather terminates at death.

Additionally, the decedent must have a beneficial interest in the property, rather than a technical legal interest. Decedents serving as trustees hold only a legal interest in the property which would not be included in their gross estate.

Community Property States

A decedent who lived in a community property state, or a state treating each spouse as owning one-half of the value of marital property, will include one-half of the value of marital assets in his or her gross estate.

Transfers With a Retained Life Interest

Common sense would say if a decedent made a gift during life, that gift would not be included in his or her gross estate at death. However, some lifetime gifts will be included in a decedent's gross estate if the gift has "strings" attached.

A decedent's gross estate will include the value of a lifetime transfer under IRC Sec. 2036 if:

1) The transfer was made during life,

2) The decedent retained:

$image\bullet.jpg$ Possession of the property transferred,

$image\bullet.jpg$ A right to income from the property transferred, or

$image\bullet.jpg$ A right to designate the person who shall enjoy the property.

3) The decedent's interest lasts for:

$image\bullet.jpg$ The decedent's life,

$image\bullet.jpg$ A period not ascertainable without reference to the decedent's death, or

$image\bullet.jpg$ A period not ending before the transferor's death.

Transfer of a Reversionary Interest

Allan, a devoted dad, became distraught upon hearing the news of his daughter's recent life-threatening illness. He wants to help his daughter out financially with her medical bills, while still providing for his wife and himself.

Allan decides to form a trust benefiting his daughter, and upon her death the property will revert back to him and his wife. Should Allan worry about the trust property returning to his gross estate upon his death?

Allan has established a trust with a reversionary interest, an interest with the possibility that the property transferred may return to the transferor, his estate, or be subject to a power of disposition by the transferor (or any third person).

A reversionary interest is included in a decedent's gross estate under IRC Sec. 2037 if:

$image\bullet.jpg$ Decedent owns a reversionary interest in the property

$image\bullet.jpg$ The actuarial value of the reversionary interest immediately before the decedent's death is more than 5%

$image\bullet.jpg$ The beneficiaries must survive the decedent to receive the transferred property

Transfers With a Power to Revoke

If a decedent held the power to alter, amend, revoke, or terminate an interest in property, the property interest is included in the property owner's gross estate. This usually occurs when property is transferred to a trust. Any of the following powers a decedent held at death will pull property back into the decedent's gross estate, under IRC Sec. 2038:

$image\bullet.jpg$ The power to revoke or terminate the trust

$image\bullet.jpg$ The power to control and manage the corpus of a trust (except when the power is concerned with mechanics or details)

$image\bullet.jpg$ The power to change beneficiaries or to vary the distribution amounts

$image\bullet.jpg$ The power to appoint the property by will or to change shares

$image\bullet.jpg$ The power to invade the corpus of a trust created by another for whose benefit the decedent created a similar trust (reciprocal transfers)

Lesson Learned: An estate owner should not retain any power to revoke or alter a property transfer if reducing estate tax liability is among the motives for the transfer.

Transfers Within Three Years of Death

Peter, who is suffering from a life threatening illness, seeks the advice of an attorney on how to reduce his estate size and cut down the amount of federal estate taxes potentially imposed on his estate. Peter owns a reversionary interest in a piece of real estate. Being somewhat informed of the estate tax laws, Peter knows that the reversionary interest will be included in his gross estate upon his death. Immediately, Peter transfers the reversionary interest to his nephew, Paul.

Peter passes away six months later. Did Peter accomplish his goal of reducing his estate size by removing the reversionary interest from his property?

Peter failed to accomplish his goal of reducing his estate size. Generally, a decedent will not be subjected to federal estate tax for completed gifts made during his or her lifetime. However, the Internal Revenue Code discourages "deathbed transfers" by including in a decedent's gross estate certain transfers made within three years of death.

The "three-year rule" of IRC Sec. 2035 applies basically to three situations:

Within three years of death, the decedent relinquished:

$image\bullet.jpg$ A life interest

$image\bullet.jpg$ A power to revoke or a reversionary interest (following the restrictions listed in the above sections) that was retained when the decedent made a previous lifetime transfer

$image\bullet.jpg$ Incidents of ownership in a life insurance policy on the decedent's life (following the restrictions listed in this section)

Annuity Death Benefits

Annuities, or agreements providing a fixed sum of money for a specified period of time, will be included in a decedent's gross estate only if certain conditions are met.

$image\bullet.jpg$ Agreement or Contract—The agreement must be an annuity, or a similar contract or agreement, that is not an insurance policy, to be included in the decedent's gross estate. This includes not just commercial annuity contracts, but also death benefits paid from employer retirement plans, IRAs and nonqualified deferred compensation plans.

$image\bullet.jpg$ Benefits Payable to Surviving Beneficiary—Only annuities which continue to provide payments to surviving beneficiaries after the decedent dies will be included in the decedent's gross estate. If the decedent was receiving payments under a straight life annuity with no survivor benefit or refund feature at the time of death, nothing is included in the gross estate. This is because there is no continuing value in the annuity that passes to anyone else. It simply terminates.

$image\bullet.jpg$ Nature of Decedent's Interest—A decedent must have possessed the right to receive the benefits under an annuity contract payable to the decedent for: (1) his lifetime, (2) a period of time not ascertainable without reference to his death, or (3) any period which does not end in fact before his death.

IRAs, QRPs & Nonqualified Deferred Compensation

The annuity rules apply to survivor or death benefits payable under qualified retirement plans, 403(b) plans, 401(k) plans, IRAs and nonqualified deferred compensation plans, as well as commercial annuities.

Death or survivor benefits payable from IRAs or any type of employer retirement plan are reached by IRC Sec. 2039, the section that deals with the estate taxation of annuities. This is true even if benefits have been arranged so that they are paid in a lump sum at decedent's death (rather than over time as an annuity).

Valuation

Only the proportion a decedent contributed to the purchase price of an annuity will be included in a decedent's gross estate. If the annuity was purchased jointly with another who provided 50% of the purchase price, only 50% of the value of the annuity is included in the decedent's gross estate. Contributions made by the decedent's employer towards the purchase price of an annuity are treated as contributions made by the decedent.

Jointly Held Property with Rights of Survivorship

Walter, a wealthy property owner, wishes to leave land to his niece upon his death. As a retired judge, Walter knows about the delays, expenses and hassles associated with the probate court that supervises death transfer distributions. Walter wants his niece to avoid the probate court if at all possible. In addition, Walter is hoping to move the value of the land out of his gross estate to reduce potential estate taxes.

Walter sets up a joint tenancy with rights of survivorship over the land, naming his niece as a joint tenant. Did Walter accomplish his goals in setting up the joint tenancy with his niece?

Yes and no. Upon the death of a joint tenant, his interest immediately passes to the surviving co-tenants (which could be any number of individuals), without going through the probate court (one of the goals Walter was hoping to accomplish in forming the joint tenancy). But Walter will not be successful in removing the land from his gross estate.

Joint Tenancy With Survivorship Rights

The general rule is that property owned in joint tenancy with rights of survivorship is fully includible in the gross estate of the first co-owner to die.

Consideration Furnished Test—The decedent's gross estate may exclude a portion of the joint tenancy interest under the "consideration furnished test." Under this test, the decedent's gross estate will exclude that portion of the joint tenancy property that the decedent's executor can prove:

$image\bullet.jpg$ Originally belonged to the surviving co-tenant(s),

$image\bullet.jpg$ Was purchased by the surviving co-tenant(s), or

$image\bullet.jpg$ The survivor received, not from the decedent, property for adequate and full consideration in money or money's worth.

The executor has the burden of proving what portion of the joint-tenancy property was contributed by other co-tenants.

In calculating the gross estate, the amount included is proportionate to the decedent's contribution, based on the date-of-death value of the property, not the amount the decedent actually contributed.

Special Rule for Spouses—Spouses who own property jointly as a "qualified joint interest" include only 50% of the value of that property in the estate of the first spouse to pass away. A "qualified joint interest" is:

$image\bullet.jpg$ A joint tenancy with rights of survivorship (if only the two spouses are included in the tenancy), or

$image\bullet.jpg$ A tenancy by the entirety.

The 50% rule applies regardless of the original ownership or percentage contributions made towards the property.

General Powers of Appointment

A decedent may have possessed the power at his or her death to appoint property. The scope of this power determines whether the property flows in or out of the decedent's gross estate.

A decedent who held a general power of appointment will include the property over which he or she had the power into his or her gross estate. A general power of appointment is the ability to appoint property to a class of persons that includes the decedent himself, his creditors, his estate, or his estate's creditors.

A decedent who held a limited or special power of appointment, however, will not have the property included in his or her gross estate. A limited power of appointment is the power to appoint property to a class of persons other than the decedent, his creditors, his estate or his estate's creditors.

There are several situations where the power is technically a general power of appointment, but is not classified as one for estate tax purposes:

$image\bullet.jpg$ The power to "consume, invade, or appropriate property for the benefit of the decedent which is limited by an ascertainable standard relating to health, education, support, or maintenance of the decedent" is considered a limited power of appointment.

$image\bullet.jpg$ A power which is exercisable only by the decedent in conjunction with the creator of the power or a person having a substantial interest in the property subject to the power, where this interest is adverse to the exercise of the power in decedent's favor. (If the power may be exercised both in favor of the decedent and of the persons whose consent the decedent must have, the power is general to the extent of the decedent's fractional interest in it.)

$image\bullet.jpg$ A power which is exercisable by the decedent only in conjunction with another person.

$image\bullet.jpg$ Any general powers of appointment that are exercised, lapsed or released may fall back into the decedent's gross estate. (The lapsed power falls back into the decedent's estate in the amount exceeding the greater of either $5,000 or 5% of the aggregate value of the assets.)

Life Insurance Death Proceeds

Life insurance on the insured decedent is included in the gross estate if:

$image\bullet.jpg$ The proceeds are payable to or for the benefit of the estate, or

$image\bullet.jpg$ The insured held incidents of ownership over the policy within three years of death.

Payable to the Estate—The policy does not have to designate the estate as the beneficiary to be treated as paid to the estate. If the proceeds are paid to a trustee that is required to pay estate debts and expenses, or to a creditor to pay off the insured's debt, it is just as if the proceeds were paid to the executor who then used them for this purpose.

However, if a trustee is merely authorized rather than required to pay estate costs, then the proceeds are only includible in the gross estate to the extent they are actually used to pay estate costs.

Inclusion of the proceeds in the gross estate can be avoided if the trust document merely authorizes the trustee to:

$image\bullet.jpg$ purchase estate assets at a fair price, or

$image\bullet.jpg$ make loans on reasonable terms to the estate.

Incidents of Ownership—"Incidents of ownership" includes a variety of rights and powers that an insured decedent may have held over the policy. It only takes one of these incidents, held during a three-year period before death, to bring the proceeds into the gross estate. Insureds sometimes create problems in this regard by assigning ownership of a policy during life, but retaining one of these prohibited incidents of ownership:

$image\bullet.jpg$ Right to change the beneficiary

$image\bullet.jpg$ Right to surrender the policy for cash

$image\bullet.jpg$ Right to borrow against the policy or pledge it for a loan

$image\bullet.jpg$ Right to assign the policy

$image\bullet.jpg$ Right to elect or revoke a settlement option

$image\bullet.jpg$ Right to get the policy back after a transfer (reversionary interest)

$image\bullet.jpg$ Right to exercise any other important right or power under the policy

It doesn't matter whether the insured ever actually exercised these rights; if the insured simply held them, that is enough to pull the proceeds into the gross estate. Such a right can be held directly or indirectly through the insured's power as a trustee.

In the case of a policy owned as community property, only one-half of the proceeds are included in the estate. This is an exception to the usual rule which holds that even when rights are only exercisable in combination with another person, the entire proceeds are still includible in the gross estate.

Policy On Another's Life—If a decedent owned a life insurance policy on the life of another, the fair market value of the policy is included in the gross estate. For a paid-up policy, this will be the replacement cost of a comparable policy. For any other type of policy, the value is the "interpolated terminal reserve value," which is approximated by (but not identical to) the cash value, plus a prorated portion of any unearned premium.

Valuation of Gross Estate

At Date of Death

An executor generally values a decedent's estate using the fair market value of the property at the date of death. Fair market value is defined as the "price at which the property would change hands between a willing buyer and a willing seller, neither one being of the compulsion to buy or to sell, and both having reasonable knowledge of all relevant facts."

Special rules exist for determining the fair market value of specific types of property, such as stocks and bonds, life insurance policies, annuity policies, real estate, etc.

Alternate Valuation Date

Unlike gift taxes, executors may choose between two dates to determine the value of a decedent's estate—the date of death or the alternate valuation date.

The alternate valuation date allows the executor to value the decedent's estate six months after the decedent's death, with the exception of property sold, distributed, exchanged or otherwise disposed of within the six-month period, which is valued on the date of disposition. In order for the executor to make the election, the value of the decedent's estate must have decreased as well as the amount of potentially due estate tax.

The executor elects the alternate valuation date on the federal estate tax return, and cannot change this election on an amended return. Once the election is made, the valuation date is irrevocable.

Special Use Valuation

Typically estate property is valued using the "highest and best use" standard. Congress discovered family owned farms and businesses were struggling under this valuation system. A family farm could have been worth $400 per acre as put to use by the decedent, but $4,000 per acre to a real estate developer. Under the normal valuation system, the family may be forced to sell the farm, in order to pay the estate taxes.

Special use valuation provides that, if certain conditions are met, the executor may elect to value real property, which is devoted to farming or closely held business use and is included in a decedent's estate, on the basis of the property's "current use" rather than its "highest and best use." The maximum reduction in value under this provision is $1,420,000 (as indexed for 2025). Special use valuation eases both the estate tax burden and liquidity needs of the estate, often allowing property to remain in the family or family business.

Special Use Valuation Qualification Criteria

$image\bullet.jpg$ The value of the farm or closely held business assets (reduced by debts attributable to such assets) in the decedent's gross estate, including both real and personal property, must be at least 50% of the adjusted value of the gross estate. For purposes of this calculation, the property is valued on its "highest and best use" basis.

$image\bullet.jpg$ "Adjusted value of the gross estate" for purposes of this provision means the gross estate less unpaid mortgages, or indebtedness against property included in the gross estate.

$image\bullet.jpg$ At least 25% of the adjusted value of the gross estate must consist of a qualified farm or closely held business real property.

$image\bullet.jpg$ The real property qualifying for special use valuation must pass to a qualified heir—the decedent's spouse, descendants, ancestors, siblings, the descendants of the decedent's parents, the descendants of the decedent's spouse, or the spouses of the lineal descendants of the decedent.

$image\bullet.jpg$ Such real property must have been owned by the decedent or a member of his or her family and used or held for use as a farm or closely held business for at least five of the last eight years prior to the decedent's death.

$image\bullet.jpg$ There must have been material participation in the operation of the farm or closely held business by the decedent or a member of his or her family in five out of the eight years immediately preceding the earliest of: (a) the decedent's death, (b) the date on which the decedent became disabled, or (c) the date on which the decedent began receiving Social Security retirement benefits.

If the qualification tests are met, the value is determined as follows:

$image\bullet.jpg$ The excess of average annual gross cash or crop share rental for comparable land use

$image\bullet.jpg$ Minus the average state and local real estate taxes for such comparable land

$image\bullet.jpg$ Divided by the average annual effective interest rate for all new federal land back loans.

This formula cannot reduce the value by more than $1,420,000 in 2025, as indexed.

If the heirs sell the property outside the family, or the property ceases to be used for farming or business purposes, within 10 years, the tax savings from special-use valuation is recaptured [IRC Sec. 2032A].

Partial Interest

Partial interest refers to life estates, remainder interests, reversionary interests and annuity interests in property. The common characteristic here is that the beneficial ownership of property is split between two or more persons. The valuation task is to assign a value to each interest that will add up to the value of the whole.

Fortunately, the IRS provides valuation tables for this purpose. These tables use time value of money factors to arrive at the value of limited interest. Thus, the relevant considerations are:

$image\bullet.jpg$ The period an income interest or annuity will last, or that a remainder or reversionary interest will be delayed, both based on average life expectancies or a specified term of years

$image\bullet.jpg$ The interest rate assumed for discounting and compounding

$image\bullet.jpg$ The amount of the periodic payment or the value of the whole

The IRS is required by law [IRC Sec. 7570(c)(3)] to revise the tables for valuing partial interests at least once every 10 years to reflect more recent mortality data. New tables were released by the I.R.S. on May 1, 2009.

The IRS requires the use of prevailing interest rates (for discounting and compounding) in the valuation of partial interests. The IRS issues new rates monthly, and one enters the partial interest tables with the appropriate current interest rates.

Estate Tax Deductions

Funeral expenses

After a value has been placed on the gross estate, certain deductions are permitted to calculate the "adjusted gross estate". An executor may deduct funeral expenses to the extent allowed by the laws of the jurisdiction where the estate is being administered. The funeral expenses will be deducted to the extent of the amount actually paid by the executor or administrator.

Here is a review of the situations where the deductibility of funeral expenses is limited.

Funeral expenses include payment of: tombstones, monuments, burial lots, transportation of the body, and future care of the lot. The deductibility of funeral expenses is limited in several situations:

$image\bullet.jpg$ The deductibility of funeral expenses in community property states is conditioned on whether the expenses are determined to be expenses of the marriage community or the decedent's estate. Expenses of the community estate will allow the decedent's estate to deduct only one-half of the expenses. Expenses of the decedent are deductible to the full extent paid.

$image\bullet.jpg$ Social Security and veterans benefits will not be deductible by the decedent's estate.

$image\bullet.jpg$ The decedent's estate may not deduct funeral expenses in states requiring the surviving spouse to pay for funeral and burial expenses.

Administration Expenses

Expenses must be actually and necessarily incurred in the administration of the estate to be deductible as an administration expense. Deductible administration expenses include:

$image\bullet.jpg$ Collection of assets

$image\bullet.jpg$ Payment of debts

$image\bullet.jpg$ Attorney's fees

$image\bullet.jpg$ Executor's commission

Administration expenses for an individual beneficiary's specific benefit may not be deductible. Only expenses connected with the transfer of property to the beneficiaries or trustees may be claimed as an administration expense deductions.

In community property states, administration expenses may be deducted to the extent allowed under state law.

Debts of a Decedent

Personal debts of a decedent will be deductible to his or her estate to the extent of: (1) the value of the claims at the time of death, or (2) the claims representing "bona fide obligations contracted for full and adequate consideration in money or money's worth."

Interest on the debt will also be deductible to the extent it accrues up to the time of decedent's death (even if the executor chooses to use the alternate valuation date).

To the extent the debt exceeds the value of the property, the deduction is disallowed to the extent of the amount exceeding the value of the property.

Losses During Estate Administration

Casualty losses occurring during the settlement of an estate, not compensated by insurance or a third party, may be deducted. A casualty loss includes losses by: fire, storm, shipwreck and war. Depreciation does not qualify for the deduction.

Mortgages

An executor may deduct from an estate the amount of a mortgage or lien included in the decedent's gross estate if the full value of the property, unreduced by liens, is included in the gross estate.

Estate Tax Marital Deduction

At a Glance

Congress enacted the unlimited marital deduction to allow death transfers between spouses without potential estate tax liability.

To qualify for the martial deduction, the following requirements must be met:

$image\bullet.jpg$ Marital Relationship—The recipient must have been married to the decedent at the time of death. Whether a couple is legally married is determined under state laws. Some states recognize "common law" marriages as a legal marriage relationship, where cohabitation has lasted for some period of years.

$image\bullet.jpg$ United States Citizenship or Residency—The marital deduction is generally available for federal estate tax purposes for the estates of U.S. Citizens, resident aliens, and nonresident aliens, where the surviving spouse is a U.S. citizen. If the surviving spouse is not a U.S. citizen, the marital deduction is generally only available if the property is in a qualified domestic trust.

$image\bullet.jpg$ Inclusion in the Gross Estate—The marital deduction applies only to property included in the gross estate. This makes sense since only that property is potentially subject to tax at the decedent's death.

$image\bullet.jpg$ Passing Requirement—Only property that "passes" from the deceased spouse to the surviving spouse is eligible for the marital deduction. Property may "pass" in a variety of ways, including: bequest, spousal share, beneficiary designation, jointly-held property, etc.

$image\bullet.jpg$ Deductible Interest—Only deductible interest transfers will qualify for the marital deduction. Generally only three types of transfers are classified as non-deductible interest, including: (1) an interest not included in the gross estate, (2) property subject to a casualty loss, and (3) a terminable interest.

Unlimited Amount Deduction

An executor may claim an unlimited 100% deduction on property transferred between spouses at death.

Bequests of Nonterminable Interests

Certain restrictions or limitations on the surviving spouse receiving the property will disqualify the transfer for the marital deduction.

To qualify for the marital deduction, the property that passes to the surviving spouse (or the donee-spouse in the case of a lifetime gift) must not be a "terminable interest." That is, the spouse's interest must not be subject to expiration due to the passage of time, the occurrence of some future event, or the failure of some future event to occur. If any of these things can happen, then he or she has a disqualified terminable interest.

Here are the five main exceptions to the nonterminable interest rule:

1. Survivorship Exception—The marital deduction may still be claimed on a transfer to a surviving spouse conditioned on the spouse surviving the decedent by at least six months or not dying in a common disaster.

2. Life Estates with a Power of Appointment—The marital deduction may be claimed when the death transfer provides the surviving spouse with all of the income from the property for life, and an unqualified general power to appoint the property to himself or his estate.

3. Interest to the Surviving Spouse in the Proceeds of Life Insurance—The marital deduction may be claimed for: death transfers of life insurance, endowment or annuity contracts held by the insurer if the surviving spouse has the right to all interest and installment payments, and the general power to appoint the residue to himself or his estate.

4. Qualified Terminable Interest Property—For complete information see QTIP Trusts in this section.

5. Charitable Remainder Trust—For more information on spousal interest, see the Charitable Remainder Trust section.

The "Estate Trust"

The "estate trust" is a trust arrangement where the trust income is accumulated, rather than paid out annually. The income must then be only paid to the surviving spouse for life, with the trust corpus (including the accumulated income) paid to the spouse's estate at death.

Life Estate with a General Power of Appointment

The surviving spouse can be given a life estate in property, coupled with a general power to appoint the property to herself, her creditors, her estate or her estate's creditors. This is deemed equivalent to outright ownership of the property, and qualifies the transfer for the marital deduction.

Marital deduction trusts ("A" trusts) often utilize this exception to the terminable interest rule. The spouse is given a lifetime income from the trust with a general power to appoint the trust corpus.

Noncitizen Spouse and a Qualified Domestic Trust

Normally death transfers to a non-citizen spouse will not qualify for the estate tax marital deduction. However, if property is transferred to a non-citizen spouse via a qualified domestic trust (QDT), the transfer may qualify for the marital deduction. (If a nonresident alien passes property at death to a U.S. citizen-spouse, the marital deduction will be allowed.)

A QDT qualifies for the estate tax marital deduction if the trust:

$image\bullet.jpg$ Requires at least one of the trustees to be either a United States citizen or a domestic corporation.

$image\bullet.jpg$ Provides that the trustee maintain the right to withhold from distribution the tax imposed on such distribution.

$image\bullet.jpg$ Meets the requirements imposed by U.S. Treasury Regulations.

Elects to qualify the trust for the marital deduction on the decedent's estate tax return.

The federal government imposes an estate tax on any corpus distributions from the QDT during the surviving spouse's lifetime, and on the value of the QDT upon the death of the surviving spouse.

Estate Tax Charitable Deduction

Unlimited Deduction

Unlike the income tax charitable deduction, the estate tax charitable deduction is unlimited, meaning 100% of the value of qualifying charitable transfers will not be subject to estate taxation.

Qualified Organizations

To qualify for the estate tax charitable deduction, the transfer must be to an organization under the following categories:

$image\bullet.jpg$ The United States, any state, any political subdivision, or the District of Columbia, for exclusively public purposes

$image\bullet.jpg$ Any corporation organized and operated exclusively to support the following causes:

$image\bullet.jpg$ Religion

$image\bullet.jpg$ Charity

$image\bullet.jpg$ Science

$image\bullet.jpg$ Literature

$image\bullet.jpg$ Educational purposes

$image\bullet.jpg$ The encouragement of art

$image\bullet.jpg$ National or international amateur sports competition (but only if no part of the activities involve the provision of athletic facilities or equipment)

$image\bullet.jpg$ The prevention of cruelty to children or animals.

Note: No part of the net earnings may inure to the benefit of any private stockholder or individual. The organization must not be disqualified for tax exemption under IRC Sec. 501(c)(3) by reason of attempting to influence legislation, participating in, or intervening in any political campaign on behalf of (or in opposition to) any candidate for public office.

$image\bullet.jpg$ to a trustee or trustees, or a fraternal society, order, or association operating under the lodge system, but only if such contributions or gifts are to be used exclusively for the same causes described in the previous bullet point.

Note: Such trust, fraternal society, order, or association must not be disqualified for tax exemption under IRC Sec. 501(c)(3) by reason of attempting to influence legislation. Such trustee or such fraternal society, order, or association, must not participate in, or intervene in (including the publishing or distributing of statements), and political campaign on behalf of (or in opposition to) any candidate for public office.

$image\bullet.jpg$ Any veterans' organization incorporated by Act of Congress, or any local chapters or posts;

Note: No part of the net earnings may inure to the benefit of any private shareholder or individual.

$image\bullet.jpg$ An employee stock ownership plan.

Note: The ownership plan must be a qualified gratuitous transfer of a qualified employer securities as defined under IRC Sec. 664(g).

CRT & Other Partial-Interest Bequests

Donors often want to provide a bequest to both a charitable and non-charitable beneficiary, or a split-interest bequest. The question then becomes whether the transfer qualifies for the estate tax charitable deduction.

Normally the split-interest transfer will not qualify for the charitable deduction. However, the Internal Revenue Code sets out certain exceptions, including:

$image\bullet.jpg$ Charitable remainder annuity trust

$image\bullet.jpg$ Charitable remainder unitrust

$image\bullet.jpg$ Pooled income fund

$image\bullet.jpg$ Remainder interest in a personal residence or farm

A donor may give a remainder interest in a personal residence or farm (including a ranch) to a charitable organization if the interest is not transferred via trust. The donor must transfer an interest in the actual property, not the proceeds flowing from the sale.

$image\bullet.jpg$ Undivided Portion of Donor's Entire Interest

A donor may transfer outright an undivided portion of the donor's entire interest in property to a qualified charitable organization. To qualify, the interest may not pass by trust, and must extend over the entire period of the donor's interest in the property.

$image\bullet.jpg$ Qualified Conservation Contributions

A partial interest in real property may be given outright for certain conservation purposes and secure the estate tax charitable deduction. Acceptable conservation purposes include:

$image\bullet.jpg$ Preserving land for outdoor recreation

$image\bullet.jpg$ Protecting wildlife

$image\bullet.jpg$ Maintaining open spaces

$image\bullet.jpg$ Safeguarding historically important land areas or a certified historic structure

Jeopardizing the Estate Tax Charitable Deduction

Contingent bequests—No charitable deduction will be allowed for a bequest made contingent on the happening of an event, unless the possibility of the charity not receiving the bequest is so remote to be negligible.

Unascertainable amount of charitable bequests—To qualify for the charitable deduction, a death transfer must be ascertainable and clear as to the amount of the charitable bequest. The United States Supreme Court said a clear gift is one which is, "ascertainable at the date of death of the amount going to charity."

Computing the Estate Tax

Determining the Taxable Estate

Frank wants to accomplish several goals in making his will. First, he wants to provide for his wife, his nephew, and his church. Most importantly, Frank does not want his $17,600,000 estate to be consumed by estate taxes.

Frank sets up a will leaving $2,000,000 to his wife, $15,000,000 to his three children and $500,000 to his church. As advised by his accountant, Frank made a lifetime gift to his nephew of $613,000 back in 2010. Frank anticipates funeral and administration expenses totaling $100,000. How would you determine Frank's potential estate tax liability at death?

First, Frank must identify the property and its value to be included in his gross estate. Next, he must determine the amount of available deductions and subtract them from the gross estate to determine his taxable estate.

Adjusted Taxable Gifts

The lifetime taxable gifts a decedent made after December 31, 1976, or the adjusted taxable gifts, will be added to a decedent's taxable estate to determine the tentative estate tax liability. The executor will deduct the amount of the annual exclusion (at the time of the gift) in determining the amount of taxable gifts.

An executor uses the value of the gift at the time the gift was made, rather than the date the decedent died. Therefore, any appreciation in the gift property after the gift was made is ignored.

For example, Frank gave his nephew a parcel of real estate in 2010 with a fair market value of $613,000 at the time of the gift. When Frank died, the real estate was valued at $800,000. The executor would report an adjusted taxable gift of $600,000 (the gift value minus the $13,000 annual exclusion for 2010).

Tax Rates

The estate tax rates are applied to the estate tax base to arrive at the "tentative estate tax."

Estate and Gift Tax Rates (2025)

The tentative tax is:

Not over $10,000	18% of that amount
Over $10,000 but not over $20,000	$1,800+20% of excess over $10,000
Over $20,000 but not over $40,000	$3,800+22% of excess over $20,000
Over $40,000 but not over $60,000	$8,200+24% of excess over $40,000
Over $60,000 but not over $80,000	$13,000+26% of excess over $60,000
Over $80,000 but not over $100,000	$18,200+28% of excess over $80,000
Over $100,000 but not over $150,000	$23,800+30% of excess over $100,000
Over $150,000 but not over $250,000	$38,800+32% of excess over $150,000
Over $250,000 but not over $500,000	$70,800+34% of excess over $250,000
Over $500,000 but not over $750,000	$155,800+37% of excess over $500,000
Over $750,000 but not over $1 million	$248,300+39% of excess over $750,000
Over $1 million	$345,800+40% of excess over $1 million

Estate Tax Credits

After the tentative estate tax is calculated, the last step is to determine the available credit used to offset the tax liability.

Gift Taxes Paid

An executor may claim a credit for federal gift taxes paid on lifetime transfers made after 1976. Gift taxes would not be paid, of course, unless the decedent had exhausted his or her gift tax applicable credit.

State Estate Taxes

In 2005 and after, the old state estate tax credit was replaced by an estate tax deduction. State death taxes "actually paid" are deductible from a decedent's taxable estate for federal estate tax purposes.

Tax on Prior Transfers

The federal government allows a credit to be applied against estate taxes on transfers of property to a present decedent from anyone who has died within ten years before or two years after the decedent's death. The purpose of the credit is to prevent the diminution of wealth by successive rapid application of the federal estate tax.

The amount of the credit is determined based on the amount of time between the two deaths. The Internal Revenue Code provides a percentage chart to determine the amount of applicable credit, expressed as a percentage of the prior tax allowed as a credit in the present estate.

Here is the Internal Revenue Code's percentage reduction table.

Period of time exceeding	Not exceeding	Percent Allowable
0 years	2 years	100
2 years	4 years	80
4 years	6 years	60
6 years	8 years	40
8 years	10 years	20
10 years		none

Applicable Credit Amount

After the decedent's tentative estate tax is computed, the applicable credit amount ("unified credit") may be applied against the tax. A decedent who used all or part his or her available credit amount for lifetime transfers will have the credit "reappear" at death, along with the adjusted taxable gifts that used up the credit during life.

The applicable credit amount exempts $13.99 million in 2025.

Foreign Estate Taxes

United States citizens or resident decedents who own property in foreign countries (and United States possessions) at death may be subject to estate taxes on the property by both the United States and a foreign country. The U.S. government sought to eliminate this "double taxation" by implementing a foreign death credit. The credit, which must be claimed within four years after an executor files the estate tax return, exempts the amount of foreign death taxes paid by the decedent's estate and included in his or her gross estate. The credit may not exceed the amount of U.S. taxes imposed on the property.

Calculating the Federal Estate Tax

Here are the steps used to calculate the federal estate tax:

$image\bullet.jpg$ Determine what property is included in the gross estate.

$image\bullet.jpg$ Place a fair market value on each item of includible property.

$image\bullet.jpg$ Deduct administration expenses, debts of the decedent, funeral expenses, and certain losses during estate administration to arrive at the adjusted gross estate.

$image\bullet.jpg$ Subtract the value of property qualifying for the marital deduction in the case of a married person's estate, the amount of state death taxes paid, and the value of any bequests to charity, to arrive at the taxable estate.

$image\bullet.jpg$ Add to the taxable estate any adjusted taxable gifts made (after 1976 only) during lifetime to arrive at the total estate tax base.

$image\bullet.jpg$ Compute the tentative estate tax by applying the unified tax rate schedule to the estate tax base.

$image\bullet.jpg$ Subtract from the tentative estate the equivalent credit amount (formerly, unified credit), state death tax credit, foreign death tax credit, gift taxes paid on post-1976 taxable gifts, and any other credits available to arrive at the estate tax due and payable.

Here is a simple calculation of the federal estate tax for Frank's estate, assuming Frank dies in 2025:

Gross Estate	$17,600,000
Less: Charitable contributions	-$500,000
Less: Expenses at death	-$100,000
Total Estate	$17,000,000
Less: Transfer to spouse	-$2,000,000
Estate subject to taxes	$15,000,000
Add: Post -1976 taxable gifts	+$600,000
Total Estate subject to taxes	$15,600,000
Estate tax prior to applying Credit (applying 2025 tax rates)	$6,185,800
2025 Equivalent Credit (based on 2025 Estate tax exemption of $13,990,000)	$5,541,800
Estate taxes	$644,000
Total to heirs	$14,956,000

Estate Tax Return & Tax Payment

General due date

An executor is required to file a federal estate tax return, Form 706, (Form 706-NA for nonresidents) with the Internal Revenue Service. The executor generally must file the estate tax return and pay the estate taxes within nine months from the date of the decedent's death. Returns are only required if the amount of the gross estate exceeds the amount of the exemption equivalent, to the current applicable credit amount. Executors for nonresident decedents who are not citizens must file a return if the amount of the gross estate in the U.S. exceeds $60,000.

Extensions

If it is impracticable or impossible for the executor to file a reasonably complete return before the expiration of the due date, a six month extension may be granted.

Installment Payment of Estate Tax

When a closely held business or a farm is included in the gross estate, it may produce such a large tax liability that the tax cannot be paid at the regular time without forcing a sale of all or part of the business. Under the Internal Revenue Code § 6166, an executor may elect to spread out the payment of estate taxes on a closely held business or farm, by making payments in installments.

A decedent's interest in a business or farm qualifies if:

$image\bullet.jpg$ The interest is a closely held business. An interest is closely held if it is: (1) a sole proprietorship;(2) a partnership with 45 partners or less, (3) an interest in a partnership of 20% or more assets in decedent's gross estate; (4) a corporation with 45 or less shareholders, or (5) a corporation if 20% of its voting stock is included in the decedent's gross estate.

$image\bullet.jpg$ Value of the closely held business exceeds 35% of the adjusted gross estate. The adjusted gross estate is determined by taking the gross estate minus debts of decedent, funeral and administration expenses and certain losses during estate administration.

Once the election is claimed, the executor may pay the estate taxes over a period of fourteen years. During the first five years, the executor will make annual payments of interest only. Then, in the next ten years, ten annual payments of principal and interest will be made. The first payment of the tax coincides with the last payment of interest only, so the spread-out period is a total of 14 years.

State Death Taxes

At a Glance

Nearly every state has a death tax on the books. Under these state laws, it is possible that transfers of real estate and tangible personal property will be taxed in the state where the property is located or transfers of intangible property, such as insurance or stocks, will be taxed in either the state of the decedent's domicile or any other state which afforded some direct protection to the decedent's rights in such property.

Estate vs. Inheritance Taxes

State death taxes fall into one of two categories, either an estate tax or an inheritance tax (though some have both). The estate tax is the tax payable by the executor out of the estate assets, similar in form to the federal estate tax.

In contrast, the inheritance tax levies the tax on the recipient of the estate assets, rather than the estate. Each category of recipients usually has an exemption and perhaps its own tax rate schedule, both of which become increasingly less attractive as the degree of relationship to the decedent becomes more remote. Children, for example, are taxed more favorably than cousins. In many states, there is no tax on property transferred to a surviving spouse.

Credit Estate Tax

Most states have a credit estate tax based on the maximum allowable state estate tax credit under the federal estate tax system. And this is the only death tax levied by some states. In other states, a credit estate tax would be levied in addition to a basic inheritance or estate tax in order to use up any remaining federal credit available.

However, the repeal of the federal credit for state death taxes after 2005 prompted a few states to take legislative action to "freeze" their credit estate tax to the federal credit as it existed at some date prior to its repeal. Most other states did not and so have effectively allowed their state death taxes to expire.

Disclaimer

This service is designed to provide accurate and authoritative information in regard to the subject matter covered. It is provided with the understanding that neither the publisher nor any distributor is engaged in rendering legal, accounting, tax, investment, or other professional advice. If legal advice or other expert assistance is required, the services of a competent professional should be sought.

While the publisher has been diligent in attempting to provide accurate information, the accuracy of the information cannot be guaranteed. Laws and regulations change frequently, and are subject to differing legal interpretations. Accordingly, neither the publisher nor any distributor of this service shall be liable for any loss or damage caused or alleged to have been caused by the use or reliance upon this service.

Year	Eligible Amount
2023	$1,750,000
2024	$1,850,000
2025	$1,900,000