What is the Estate Tax?
Definition: An estate tax is the financial levy that is applied during the transfer of an estate from the previous owner upon death. Usually, estate owners leave a will behind that defines the process of transfer, with details like who will receive a piece of the estate and what amount. However, most estate owners that are survived by a spouse leave everything to the surviving spouse and then it becomes their responsibility to hand down the estate.
The estate tax varies across countries. Even within countries like the Unites States, there is no common approach to estate tax among the states. Interestingly, only 13 states in the US charged estate tax as of 2019. According to the US Internal Revenue Service (IRS), an estate tax takes into account everything the previous owner had in possession. This includes real estate, land, material and IP possessions, stocks and bonds, cash, and any other asset in which one had a controlling interest. Put together, all these possessions are called “Estate”.
The Process of Estate Taxation
Before arriving at the estate tax due, the IRS first considers the gross value of the estate, simply called Gross Estate. Gross Estate is the total value of all the possessions that the previous owner possessed without any deductions. However, the IRS allows for certain deductions as well as special reductions to the Gross Estate before arriving at the taxable amount or Taxable Estate. Even then, the tax applies after a certain minimum limit, which varies among the states that charge the estate tax.
Some of the deductions from the Gross Estate include debts like mortgages, administration expenses for the estate, and property donated to charities. However, the estate will not attract any tax if it is passed on to a spouse. If part of the estate goes to the spouse and the rest goes to other inheritors, the amount that goes to inheritors will attract the estate tax. The valuation of the Gross Estate is undertaken based on the current market prices of the assets that make up the estate. However, the IRS may reduce the value of some assets after a special consideration.
Each state that charges the estate tax has its own exclusion amount. However, the IRS set its exclusion amount at $11.4 million at the federal level as of 2019. As such, any extra amount transferred to beneficiaries is taxable estate. For example, Person X had Gross Estate of $100 million and after deductions the amount settled at $56 million, the IRS would consider $44.6 million ($56 million – $11.4 million) as taxable estate.
Estate Tax vs Inheritance Tax vs Gift Tax
Majority of the estate tax in the US is collected at the Federal level. In addition, the estate tax is levied on the taxable estate, which is the gross estate less liabilities and other deductions from the gross estate. On the contrary, inheritance tax is levied on the bequests that an individual receives from the previous owner. If father divided his estate equally to his children, each child would pay an inheritance tax levied on the amount received. Therefore, the beneficiaries of an estate are the ones that pay an inheritance tax.
Nonetheless, few states collect this tax in the US. The federal government does not levy this kind of tax too. In many other countries worldwide, there is no clear difference between the estate tax and the inheritance tax. As such, it is common for the terms to be applied interchangeably.
Further, the gift tax is simply a levy charged on financial gifts transferred from one person to another. Usually, authorities have in place guidelines that define how to approach the gift tax. In the US, the IRS has exclusions when computing gift tax. As of 2019, gifts worth $15,000 and less do not attract a gift tax. However, any gift that exceeds this amount is liable for taxation. For example, if you extended a $25,000 gift to another person, $10,000 of that amount is taxable gift.