estate tax

n.
A tax imposed on the right to transfer property by inheritance and assessed on the net value of a decedent's estate before distribution to the heirs. Also called death tax.

For more information on estate tax, visit Britannica.com.

A tax levied on an heir's inherited portion of an estate if the value of the estate exceeds an exclusion limit set by law. The estate tax is mostly imposed on assets left to heirs, but it does not apply to the transfer of assets to a surviving spouse. The right of spouses to leave any amount to one another is known as the "unlimited marital deduction".

Investopedia Says:
When the surviving spouse who inherited an estate dies, the beneficiaries may then owe estate taxes if the estate exceeds the exclusion limit. Because the estate tax can be quite high, careful estate planning is advisable.

In 1997, a change in U.S. laws increased the value of assets that a beneficiary may exclude from federal estate taxes - though many states have their own estate taxes. With this change of laws, small business owners became able to pass on farms and other qualifying businesses to their heirs.

Related Links:
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Waiting for a big payload from an aging relative? The chance of cashing in is lower than you think. Bursting Boomers' Inheritance Dreams
With some preparation, you can save your heirs from paying a hefty estate tax. Here are some tips. Getting Started On Your Estate Plan
Don't let bad estate planning lead to unnecessary costs and stress for your inheritors. Skipping-Out on Probate Costs
Be informed about benefits and deductions that may apply to you and avoid costly mistakes on your return. Tax-Saving Advice For IRA Holders
Estate planning is not just about the division of assets after you die. Read on to save your loved ones extra grief. Three Documents You Shouldn't Do Without
Contrary to popular belief, inheriting assets isn't always a good thing. Find out what to do if you want to disclaim them. Refusing An Inheritance

Tax imposed by a state or federal government on assets left to heirs. Under the Economic Recovery Tax Act Of 1981, there is no estate tax on transfers of property between spouses, an action known as the Marital Deduction. According to the Economic Growth And Tax Relief Reconciliation Act Of 2001, the amount of assets that each person can exclude from federal taxes is $2 million in 2006, rising to $3.5 million in 2009. In 2010, the estate tax is completely repealed, and in 2011 the estate tax law returns using 2001 rules, except that the exemption goes to $1 million. Any assets passed to beneficiaries over these limits that are not protected by Trusts are assessed estate taxes of 46% in 2006, falling to 45% in 2007 and thereafter. Many states impose their own estate taxes on top of federal levies. Careful Estate Planning, involving the writing of a will and the establishment of trusts, is essential for those wishing to minimize estate taxes. Also called Death Tax; Inheritance Tax.

A tax based on the value of property left by the deceased. The market value of an estate is subject to taxation as of the date of death or, if lower, six months later. There is an exemption, which rises in steps as shown in Table 22.

Table 22 Estate Tax Exemption Equivalent

2003 $1,000,000

2004 and 2005 $1,500,000

2006-2008 $2,000,000

2009 $3,500,000

[The estate tax is repealed for 2010 but will revert to pre-2002 rules in 2011.]
Example: Abel dies in 2003, leaving $1,250,000 worth of net Assets. The estate of Abel will pay an estate tax on $250,000. Abel's heirs may also be liable for an Inheritance Tax under their state law.

Estate taxes are taxes due to the federal government upon the death of the owner of a business or estate. At first glance, IRS figures indicate that the tax has a far greater impact on wealthy individuals than on small business owners, but representatives of the latter group insist that it has long been a dreaded levy that packs a deceptive punch among small businesses. They charge that some companies have purposefully stunted their growth in order to avoid ringing up an overwhelming estate tax debt, while others have minimized the impact only through canny—and time-consuming—estate planning. Given such sentiments, recent changes in estate tax law have been warmly received by the nation's small business community. In 2000, federal lawmakers passed a bill that would have phased out the estate tax—nicknamed the "death tax"—over a ten-year period. But President Bill Clinton vetoed the legislation, claiming that the tax affected less than 2 percent of estates, and that eliminating it would have cost $750 billion in tax revenues in the decade after the phase-out.

Federal estate taxes were first established by Congress more than 80 years ago. Since 1976, estate taxes have ranged from 37 percent to 55 percent, depending on the value of the estate, but each citizen had a one-time exemption of $675,000—dubbed the "unified credit"—that may be used against the estate tax or another federal tax known as the gift tax. In 1997, however, this one-time exemption underwent a significant change for the better for small business owners, as the balanced budget deal included a major piece of estate tax relief. Under the agreement, the exemption was increased from $675,000 to $1.3 million, provided the heirs have been involved in operating the business for at least 10 years. "This [change]," commented Janean Chun in Entrepreneur, "will be a relief to family business owners, who may have been limiting their growth to avoid paying estate taxes. It will likely allow family-owned businesses to be passed from one generation to the next, rather than having to be sold to pay inheritance taxes."

Estate Tax Payment Options

Usually, taxes on an estate are due nine months after the death of an individual. However, estates involving closely held businesses have the option of making installment payments instead. These installment payments, which include interest, can be spread out over as long as 14 years, and the first $1 million of the business's value is eligible for a low 4 percent interest rate.

MINIMIZING LIABILITY. In addition, small business owners worried about looming estate taxes can take several steps to minimize the impact. "One of the principal steps that companies take in preparing for an expected estate-tax bill is to buy life insurance on the owner or owners," wrote Nation's Business contributor Joan Pryde, "making certain that the policy is owned by the company or a life-insurance trust and that the proceeds are kept out of the owner's taxable estate. Another popular estate-planning technique involves the annual gift giving that is tax-free as long as it doesn't exceed $10,000 per recipient. The gifts can be in the form of stock or other assets."

Pryde points out that businesses can also use tax-exempt charitable bequests of business interests and trusts to minimize estate tax liability. In addition, "transferring ownership of a business through buy-sell agreements, partnerships, trusts, or outright gifts is a key component in many of the planning strategies available to minimize or eliminate estate-tax liability." Business experts caution that taking such steps may be even more important—and also even more complicated—when a small business is owned by two or more family members, since the business can potentially be hit with estate taxes every time one of the owners passes away.

Small business consultants note, however, that establishment of various estate planning initiatives generally involves a fairly significant outlay of cash in and of itself. "You can create trusts, and you can create other vehicles, but they're very costly to administer, and they're very prone to being overturned by the IRS if you don't dot every 'I' and cross every 't,"' an owner of an accounting firm told Pryde. Avoiding the estate tax, said the accountant, "creates wonderful work for accountants and lawyers, but that's not really to the benefit of the small business."

A final option for a small business owner hoping to avoid estate taxes is to sell the business before he or she dies. While such a step brings other tax issues to life, it does provide the owner with cash to pay the estate tax. But as Pryde pointed out, "often the whole point of maintaining a business is to be able to pass it on to the next generation. So selling a business is usually the last resort."

Further Reading:

Chun, Janean. "The New Deal." Entrepreneur. October 1997.

"The Estate Tax." Sacramento Business Journal. September 8,2000.

Holtz-Eakin, Douglas. "The Death Tax: Investments, Employment, and Entrepreneurs." Tax Notes. August 2, 1999.

Huddle, Ben T. "Gift-Giving during Lifetime May Prevent Estate Tax Headaches." Business First-Columbus. November 19, 1999.

Pryde, Joan. "The Estate-Tax Toll on Small Firms." Nation's Business. August 1997. "Reform Plans on Congress' Agenda." Nation's Business. August 1997.

Ventry, Dennis J., Jr. "Straight Talk about the 'Death' Tax: Politics, Economics, and Morality." Tax Notes. November 27,2000.

See also: Retirement Planning; Succession Plans