Estate valuation is the process of calculating the estate's value for federal and state estate tax purposes. It's not only the major component of determining whether an estate is liable for the tax, but it can be an invaluable tool in estate planning as well.
You can take steps during your lifetime to prevent an estate tax, or, if it appears likely that your estate may be liable for taxes, you can take steps to reduce that tax liability.
Net Estate vs. Gross Estate Values
The term "gross estate" refers to the value of assets and properties before taxes and debts are subtracted. However, the estate tax is based on the net value of an estate—the amount remaining after accounting for all available deductions, credits, and payment of liabilities into consideration.
Estate liabilities are debts owed by the decedent, such as credit card balances and mortgages. The costs incurred in processing an estate are deductible, as are state-level estate taxes at the federal level. Gifts made to charities and the value of assets transferred to a spouse can also be deducted.
Assets in the estate include properties that are wholly owned by the decedent, as well as those in which the decedent held only a partial equity interest, such as jointly-owned property held with a spouse. In this case, 50% of the property's value would be attributable to the decedent's estate. Assets that are subject to probate are factored into the net calculation, as well as assets held in revocable living trusts. Assets held in an irrevocable trust are not part of the decedent's estate for tax purposes.
Federal vs. State Estate Taxes
Available deductions, credits, and exemptions can differ between federal estate taxes and state-level taxes. As of Nov. 30, 2020, 12 states and the District of Columbia impose an estate tax. There are also seven states that impose a similar—but different—"inheritance tax." Maryland levies both estate and inheritance taxes.
Only estates with net values of more than $11.58 million are subject to the estate tax in the 2020 tax year. Estate taxes will be paid on the value beyond $11.58 million. In tax year 2021, that exclusion threshold increases to $11.7 million.
Estate Tax Rates
The rates paid on estate taxes function similarly to those paid on income tax—you pay a specific rate for the portion of the money that falls within a range. Check the chart below to see the estate tax rates as of the 2020 tax year. Keep in mind, these amounts only apply to estate values beyond the exclusion threshold. Therefore, when the chart mentions rates on amounts over $100,000, that actually applies to estates worth more than $11.59 million—the first $11.58 million are passed on tax-free.
|Estate Tax Rates|
|Column A: Taxable Amount Over||Column B: Taxable Amount Not Over||Column C: Tax on Amount in Column A||Column D: Tax Rate on Excess Over Amount in Column A|
The Internal Revenue Code provides for two valuation dates: the "date of death" or the "alternate valuation date." The date used for an estate's valuation can ultimately have major impacts on the estate's tax liability.
Date of Death Estate Valuation
The "date of the death" estate valuation refers to the fair market value of each estate asset at the time of a decedent’s death. This includes statement values on that date for bank, investment, and retirement accounts.
For publicly-traded stocks held outside a brokerage account, the high and low prices on the date of death are averaged and multiplied by the number of shares the decedent owned. If the death occurs on a day when the stock market is closed, the average prices for the stock on the trading days immediately before and after the date of death are used.
The fair market values of more valuable personal effects, business interests, and real estate properties are typically determined by a qualified appraiser.
Alternate Valuation Date
The "alternate valuation" date value is the fair market value of all assets included in the decedent’s gross estate six months after the date of death.
The personal representative, executor, or trustee of an estate is permitted to choose whether to use the date of death values or the alternate valuation date values if the estate is substantial enough to be subject to federal estate taxes.
Using the alternate valuation date can reduce the value of the estate if assets are expected to depreciate for any reason during the six months after death. The estate tax bill can thereby be reduced or eliminated entirely.
Use the Same Valuation Date for All Assets
However, there's a catch: All the estate's assets must be valued as of that alternate date, not just those that have declined in value. The executor can't use the date of death values for some assets and alternate valuation date values for others.
Some assets might increase in value over six months, potentially erasing any reduction in the overall estate value achieved by assets that have depreciated. In a worst-case scenario, this method might even result in an increased estate value over what it was six months earlier. The decision should be weighed carefully, ideally with help from a tax professional or attorney.
The sales price of an asset must be used if it's sold during the six months after the date of death and the alternate valuation date method has been chosen.
The Date's Effect on Capital Gains
Another potential downside to using the alternate valuation date is its effect on the step-up in basis which beneficiaries receive for capital gains tax purposes. A beneficiary's cost basis in an asset is either the date of death value or the alternate valuation date value, whichever is elected when the estate settles.
A taxpayer's basis in an asset is normally the dollar amount paid for an asset plus the cost of capital improvements. The taxpayer pays capital gains tax on the difference between that combined figure and the sales price. This straightforward use of cost basis won't work for inheritances—the beneficiary doesn't "pay" anything for the assets.
A lower cost basis will increase a beneficiary's tax liability if they later decide to sell their inheritances. The lower the valuation, the more likely beneficiaries will realize capital gains when and if they decide to sell.