Estate Taxes: The Lifetime Exemption

Over the past 18 months, the estate tax has been a hot topic in the news and on the floor of Congress.  Sometimes referred to as the “death tax”, the estate tax is a tax levied on “the transfer of the taxable estate of every decedent who is a citizen or a resident of the United States.”  26 U.S.C. § 2001(a).  A “decedent” is a deceased individual.  The decedent’s “taxable estate” includes the assets in a decedent’s estate after applying deductions.  Several of the available deductions and exemptions will be discussed in future posts.  For now we will just discuss the biggest of them all, the “lifetime exemption.”

The lifetime exemption gets all of the press when the media is discussing the estate tax.  When you someone in Congress or on cable TV ranting about the “estate tax” or “death tax”, this is what they are talking about.  Essentially, the lifetime exemption provides an individual the right to pass a specific dollar amount’s worth of assets to whomever they desire without incurring tax on those transfers.  Below is a chart of the federal lifetime estate tax exemptions for the past ten years and for next year:

Year Exclusion Amount Top 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2010 Repealed [1] 35%
2011 $5 million 35%
2012 $5 million 35%

To illustrate the lifetime exemption, assume that a single individual died in 2011 and has $6 million in assets.  Let’s also assume that the decedent does not read this blog, has not come in to meet with one of our estate planning attorneys and thus has not taken advantage of any other estate tax minimizing strategies (which will be discussed in future posts).  Given the $5 million lifetime exemption in 2011, the first $5 million of the decedent’s assets may be passed to his or her heirs tax free.  The remaining $1 million, however, will be subject to the estate tax ($1 million x 35% = $350,000.00 in taxes to be paid).

The estate tax is owed by the estate, not the recipients of the decedent’s assets.  Thus, the estate will have to withhold sufficient assets to make the $350,000 estate tax payment.  This means that $350,000 of assets, at least some of which could have gone to the decedent’s heirs, will have to be sold and paid to the IRS.  Accordingly, the personal representative of the estate should not disburse the estate property until the estate tax is paid (or until he or she knows how the estate tax will be paid from the estate assets).

Over the coming weeks we will discuss strategies by which the decedent could have reduced or potentially eliminated the estate taxes owed.  Stay tuned!

[1] An individual dying in 2010 would not have to pay any estate tax to transfer their assets to heirs, etc.  At the time, some were worried that allowing the estate tax to lapse would result in this.  In actuality, those concerns were largely unfounded, but there were some stories of estates legally transferring immense wealth to their heirs free of taxation. Like this one and this one.


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