Estate Tax in 2011

The estate tax might be the most discussed issue in estate planning but most certainly not the most relevant given the circumstances of most individuals. For example, almost invariably the first question I am asked by clients at our initial meeting is whether the government will inherit their entire estate or impose substantial taxes on it. Almost always, my response is “no.”

Regardless, the following are some common questions that deal with the nuances of the estate tax. 

1. What is the federal estate tax? 

The federal estate tax is a tax levied against a decedent's taxable estate by the IRS when the estate is in excess of a fixed amount. This fixed amount is known as the applicable exclusion or exemption amount. 

2. How is taxable estate calculated? 

The taxable estate is determined by subtracting certain deductions from the decedent's gross estate. IRC §2051.

The gross estate includes all of the decedent's property, real or personal, tangible or intangible, wherever located IRC §2031(a). For example, this figure includes homes in the U.S. and abroad, bank accounts, stocks, retirement accounts, mutual funds, bonds, promissory notes, copyrights, patents, yachts, jewelry, castles, planes, trains and automobiles, etc.

The deductions include items such as expenses, indebtedness and taxes. IRC §2053. The most common deduction is for the mortgage amount remaining on the decedent's home. Treas Reg §20.2053-7.

For illustrative purposes, if the decedent owned a $10,000,000 home with a mortgage balance of $3,000,000 along with a bank account worth $500,000, stocks worth $500,000, bonds worth $2,000,000 and mutual funds worth $1,000,000, then their taxable estate would equal $11,000,000. 

3. Who is affected by the estate tax? 

The estate tax is imposed on every decedent who is a citizen or resident of the United States. IRC §2001(a).

Nonresident aliens are taxed on U.S.-based property. IRC §§2101, 2103. 

4. What is the exemption amount in 2011? 

The exemption amount in 2011 is $5,000,000. 

5. What does $5,000,000 signify? 

The $5,000,000 figure signifies the maximum amount at which taxes will not be owed. For example, if a person passes away and leaves a $3,000,000 estate, then no estate tax will be due.
Conversely, if a person passes away and leaves a $6,000,000 estate, then the estate tax will be levied on $1,000,000. 

6. Does California have a state estate tax? 

For decedents who passed away after December 31, 2004, there is no California estate tax. However, for decedents who passed away earlier, there may be an estate tax due. 

7. What is the maximum estate tax rate in 2011? 

The maximum estate tax rate in 2011 will be 35%. This means that no matter how large the estate, for example $10 billion, the maximum taxation rate for such an estate will not exceed 35%. 

8. How do people plan for the estate tax? 

There are numerous planning strategies that address the challenges posed by the estate tax. The most common method to cope with the estate tax is to write an AB trust. In short, an AB trust will allow a husband and wife, who are both U.S. citizens, the opportunity to leave to their beneficiaries, tax-free, double the estate tax exclusion amount. The link will provide more detail about this. 

9. Is the estate tax relevant given the high exemption amount? 

The answer depends on who is answering the question. For the wealthy individual, the estate tax is a huge estate planning issue since taxation can consume a significant portion of their estate. However, since very few people have over $5,000,000 in assets, there is no need to be concerned with a largely irrelevant issue. Out of the millions of people who will pass away next year, maybe a few thousand or less will be affected by the estate tax. 

10. Will the estate tax ever be an issue for me? 

Since the estate tax is a controversial and fluid issue, the estate tax will continue to be relevant. For example, the chart below shows the estate tax exemption amount and rates for each year since 2001. The chart shows that the estate tax has been subject to fluctuations over the past decade.

Year                    Amount Excluded                   Maximum Tax Rate


2001                   $675,000                                  55%


2002                   $1 million                                 50%


2003                   $1 million                                 49%


2004                   $1.5 million                              48%


2005                   $1.5 million                              47%


2006                   $2 million                                 46%


2007                   $2 million                                 45%


2008                   $2 million                                 45%


2009                   $3.5 million                              45%


2010                   Repealed 0%                           (restrictions apply)


2011                   $5 million                                 35% 

11. Does a high estate tax exclusion amount render estate planning irrelevant? 

Regardless of the consequences of a high estate tax exclusion amount, there are many issues in estate planning that affect a large portion of the population. For example if a person's estate is, generally speaking, in excess of $100,000, then upon that person's passing, a probate will be needed to distribute the estate to the beneficiaries. Since probate is quite expensive and lengthy, the avoidance of it is recommended by estate planning attorneys. Thus, people write trusts to avoid probate. 

12. Are there tax laws related to the estate tax? 

Yes, there are many tax laws related to the estate tax. One important related law is the gift tax. The gift tax was enacted to prevent people from giving away, or gifting, all of their estate in order to avoid paying the estate tax. Thus, the gift tax caps the amount a person may gift to another person. The recently amended estate tax law, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, increased the amount of the lifetime gift tax exemption from $1,000,000 to $5,000,000. 

13. Why is the estate tax such a controversial issue? 

The estate tax is a controversial issue because political ideologies clash markedly. There are plenty of other arguments for and against the estate tax but here is one from each side. Progressives see the estate tax as preventing dynastic transfers of wealth that create trust fund babies who lack the necessary ambition in life to succeed. Conversely, conservatives see the estate tax, or Death Tax as they like to call it, as an unfair form of taxation because the estate has already been levied an income tax. 

14. Who benefits from the estate tax? 

Clearly the federal government benefits because the estate tax generates billions of dollars of revenue for it. Also, estate planning attorneys, financial advisors, certified public accountants and associated professionals benefit from the estate tax because the very wealthy enlist their help to cope with the estate tax. 

15. When was estate tax instituted? 

The estate tax was first enacted in 1916. Since then, it has been amended numerous times. 

16. Can the estate tax be repealed? 

Yes, like any law, the estate tax can be repealed. 

17. What happened in 2010? 

Due to partisan squabbling, Democrats and Republicans were unable to amend the estate tax for 2010, which caused a temporary repeal. I do not know of any estate planning attorney who thought this would happen. This meant that regardless of the size of the decedent’s estate, no estate tax would be due in 2010.

However, other portions of the estate tax law changed in 2010 as well, most notably the “stepped-up basis” rules. In understandable language, “stepped up basis” means that a beneficiary inherits the basis of the property at the date of death value from the decedent. IRC §1014. For example, if the decedent purchased a home for $100,000 and when they died was worth $1,000,000, the beneficiary would inherit the property for $1,000,000. Then when the beneficiary later sells that asset for $1,000,000, no taxes would be due because no capital gain would have taken place.

Consequently, the vast fortunes of people such as George Steinbrenner, the former owner of the New York Yankees, and Dan Duncan, a Texas multi-billionaire, were seemingly going to be transferred tax-free to their heirs. However, due to the estate tax law, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, the heirs of these fortunes are now confronted with the option of using the estate tax rules of 2010, with its unlimited estate tax cop but limited the stepped up basis rules, or the estate tax law of 2011 with its estate tax cap of $5,000,000 but with an unlimited amount of stepped basis. 

If you have any questions please call my office (408) 866-8382 for a complimentary consultation or email me, s.miri@mirilaw.com.