Federal Estate Tax

A tax on transferring property after death

U.S. Federal Estate Tax Return
•••  IRS

The federal estate tax was repealed as of January 1, 2010, but then it was resurrected retroactively back to January 1 on December 17. This tax is collected on the transfer of a person's assets to his or her heirs and beneficiaries after his death. The total tax due is calculated by adding up the fair market values of all the decedent's assets as of his date of death, although the executor of his estate retains the right to have everything valued on an alternate date. Credits and allowable estate tax deductions are subtracted from the total, then a percentage of tax applies to the balance over a certain threshold called an exemption.

Who Is Subject to the Federal Estate Tax?

The estates of each and every U.S. citizen are subject to the federal estate tax, but very few estates actually have to pay it. The Internal Revenue Code effectively gives each U.S. citizen a "coupon" to apply against his estate tax bill—the exemption. This exemption was worth $3.5 million in 2009, and it was worth $5 million in 2010 and 2011. It increased to $5.12 million in 2012, then to $5.25 million in 2013. By 2014, it was up to $5.34 million, then it increased again to $5.43 million in 2015 and to $5.45 million in 2016 before reaching $5.49 million in 2017.

So how does this exemption work? If the value of the net estate—the gross estate reduced by allowable estate tax credits and deductions—does not exceed $5.49 million or the current amount of the exemption, the estate will pass to its heirs and beneficiaries free from federal estate taxes. If the net estate exceeds $5.49 million, only the value over this amount is taxed.

A Little History of the Estate Tax

Under the provisions of the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010—"TRUIRJCA" for short—the estate tax exemption was indexed for inflation, which meant that it would increase incrementally each year to keep pace with the economy. TRUIRJCA set the tax rate at 35 percent. These provisions were only supposed to remain in place until December 31, 2012, at which time the federal estate tax laws were supposed to revert back to those that were in effect in 2002.

This meant that on January 1, 2013, the federal estate tax exemption was supposed to drop all the way down to $1 million again and the tax rate would jump to 55 percent. But Congress and President Obama acted in the early days of 2013 to pass the American Taxpayer Relief Act—"ATRA" for short—which made permanent the changes to the rules governing estate taxes, gift taxes and generation-skipping transfer taxes implemented under TRUIRJCA.

This portability of the estate tax exemption between married couples, which was introduced for the first time under TRUIRJCA, was also made permanent. This portability provision allows the estate of one spouse to shift any unused federal estate tax exemption to the surviving spouse so she might inherit from him without her estate exceeding the exemption in the year of her own death.

What Happens If an Estate Is Taxable?

When a gross estate exceeds the federal estate tax exemption for the year of the decedent's death, the estate must file a federal estate tax return called Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return. Form 706 must be filed with the IRS within nine months of the decedent's date of death. The estate tax payment is due at the same time Form 706 is due. Although an automatic extension can be applied for using Form 4768, Application for Extension of Time To File a Return and/or Pay U.S. Estate (and Generation-Skipping Transfer) Taxes, the payment itself cannot be delayed without accruing interest.

If the decedent's estate doesn't owe a tax because its value doesn't exceed the exemption amount and the executor wants to give the portability bump to the surviving spouse, a federal estate tax return must be filed even though a tax isn't due. The return will simply indicate that the portability option is being exercised, alerting the IRS to the fact.