Federal Estate Tax Basics

The Eiffel Tower is the Empire State Building after estate taxes. - K. Kong

Federal taxes related to estate planning are multi-faceted. There are three interrelated taxes that need to be considered to minimize the total tax liability of the estate. In addition, there are income tax ramifications to many estate planning strategies that must be calculated in order to get the lowest possible tax bill.

Although there is a separate federal estate tax, tax liability is computed on the basis of what is called the federal unified transfer tax. The unified transfer tax is made up of three distinct, but closely related, taxes: the estate tax, the gift tax and the generation skipping transfer (GST) tax. The federal estate tax is an excise tax levied on the transfer of a person's property at the time of the person's death. It is not a tax on the property itself or a tax on the privilege of an heir to receive the property. Nonetheless, it is a tax that potentially reduces the amount of property available for transfer. Both the federal gift tax and the GST tax have their own sets of rules and planning strategies, but for purposes of this discussion, we'll only briefly introduce them and point out their main purpose: to prevent avoidance of the estate tax. Without the gift and GST taxes, individuals - particularly wealthy individuals - could get out of paying the estate tax by making lifetime transfers.

The unified transfer tax is computed based upon the value of the property that is considered to be in your gross estate at death, including the value of taxable gifts that you made during your life. Generally, if the total of your lifetime taxable gifts and the value of the property that you own as of the date of your death exceeds the limit, you may owe a transfer tax on the amount over this threshold.

The statutory threshold amount is $5 million, but this amount is indexed for inflation beginning after 2011. Thus, it was $5 million in 2011 and $5,120,000 in 2012. For 2013, the amount is $5,250,000.

If this tax applies, it will be steep: the maximum tax rate was 35 percent in 2011 and 2012. Beginning in 2013, it is 40 percent.