¶ … Tax Estate taxes are an important part of financial planning, especially for those who have significant assets they wish to leave to others when they die (Bradford, 2010). Wealthy individuals like John and Jane Smiley may be able to avoid the death tax, depending on how great a level of wealth they actually have. For those who are close to the threshold, as the Smiley's may be, it is very important for them to understand the death tax, so they can take any legal steps they choose in order to mitigate the level of tax they will be asked to pay. To that end, the Smiley's need to understand how much their estate can total before they need to pay the tax, so they will be prepared for any tax that will be left behind and the responsibility of their personal representative when they pass away. Since they have no knowledge of the estate tax or how it works, it will be better to explain it to them from the standpoint of the IRS information and then clear up any questions they have beyond that.

According to the IRS, the estate tax "is a tax on your right to transfer property at your death" (IRS, 2013). In other words, a person is allowed to transfer the property but they must pay a tax for the right to do so. There will be an accounting of everything that person has an interest in and everything he or she owns outright at the time he or she passed away, and this information will be collected on Form 706 (IRS, 2013). The value of the items when the person collected them or the amount he or she paid for them does not matter. What the IRS will look at is the fair market value of the items at the time of the person's death (IRS, 2013). Because of that, there may be items that are worth more or less than they were at the time the person acquired them. Everything together makes up the "gross estate," which can include securities, real estate, trusts, business interests, annuities, insurance policies, cash, and other assets such as cars, boats, and furniture (IRS, 2013).

However, a person will generally not have to pay estate tax on the entire gross estate (Shapiro & Graetz, 2005). There are deductions that can be taken to reduce the value of everything a person own (Bradford, 2010). That will make up the person's taxable estate. It may help to think of the assets like a paycheck. A person has his or her gross estate, which is like his or her gross income. It includes everything, but then there are deductions removed, like the deductions that are taken from a paycheck. This leaves the taxable estate, which is similar to the net income on a paycheck -- it is what the person has due and payable to him or her after all the deductions are removed, so it is what he or she truly received. In the grand scheme of things the gross income does not matter, because it is not what the person is given. For estate tax purposes, deductions will be removed from the gross estate, and what is left after the deductions are used will be the taxable estate. That is what the person will officially leave from the standpoint of actual assets when he or she passes on, and the amount on which taxes will have to be paid to the government (IRS, 2013).

The deductions are very important. They must be accurate, but a person wants to be sure to get all the deductions he or she legally can to reduce the amount his or her heirs will have to pay on what he or she leaves behind for them (Bradford, 2010; Shapiro & Graetz, 2005). Mortgages can be deducted, as can other debts (IRS, 2013). The expenses for administering the estate are deductions, and anything a person leaves to a qualified charity or a surviving spouse can also be deducted (IRS, 2013). If the estate qualifies for a reduction of estate tax based on an operating farm or business interest, that can also be included (IRS, 2013). Once a person arrives at a net amount, the value of lifetime taxable gifts is added to that number, starting with gifts given in 1977 (IRS, 2013). In other words, gifts that were given to heirs from that date forward have to be included. One cannot avoid the estate tax by giving all of his or her money away before death (Bradford, 2010).

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That sounds confusing, but Form 706 provides information to walk a person through the calculations step-by-step. For those with simple estates, the filing of an estate tax return may not even be necessary (Bradford, 2010). If a person does not have jointly held property with anyone else, and he or she does not have special deductions, he or she will be able to avoid filing this return in most cases. As of 2013, a person does not need to file an estate tax return for combined gross assets less than 5,250,000 (IRS, 2013). Most people do not have this much in assets, so they do not need to do anything special with their taxes (Shapiro & Graetz, 2005). Their heirs will not have trouble inheriting from them, and there will be no need to file special forms. Many people think they will give a lot of gifts during their lifetime so the value of their estate will be lower when they die. This will avoid the tax on their estate and save their heirs money.
However, the tax is calculated on the estate at the time of the person's death as well as the lifetime gifts that person has made, so handing over property before death to avoid the tax is not something that works.

It is not just the federal government that collects estate tax, either. Many states also have their own version of estate tax that must be paid. Fortunately, Florida is not one of them (State of Florida, 2012). While a person may have to file an estate tax return, he or she should not have to pay any actual tax because there are credits the state gives against what has been paid in federal taxes (State of Florida, 2012). The personal representative of the estate will need to determine whether any forms have to be filed in order to release the automatic estate tax lien Florida places on the estate when a person dies (State of Florida, 2012). It is important to note, though, that no money will have to be paid in estate tax.

Taxes are often confusing for many people, and can be more so when it comes to wealthy clients. That occurs because there are additional taxes that less wealthy individuals would not have to consider. If a person has come into recent wealth, he or she may not be aware of all the tax implications. The same is true for those who have held wealth for some time if they have had advisors or others handling their taxes for them. It is very important to discuss the total, overall wealth a person has, with the understanding that it includes every asset that person has. Most people think of their homes and the money in their bank account, but there is much more to the issue. As can be seen from the IRS information provided earlier, nearly anything can be considered an asset. Going over each category very carefully is an excellent way to make sure nothing is missed and all assets are reported properly.

With the Smiley's the first part of the agenda will be to find out what they do and do not know about the estate tax. The information provided here can then be offered to them, and they can provide information on all of their assets to see if they meet the estate tax threshold. If they do meet it, or if they are close to it and may meet it in the future, it is important they understand how it will impact them. Leaving property to a surviving spouse is one of the ways to avoid tax on that property, so that is something worth discussing. However, when the surviving spouse dies there will not be another spouse to leave things to. That is where the estate tax is more likely to surface, but careful planning can keep the estate as straightforward as possible, so it will be easier to pay the tax and move forward when the personal representative settles the estate. The goal is not about avoidance of the tax, but about legal protection from as much of it as possible and an understanding of the rest of it.

References

Bradford, B.T. (2010). The Estate Planning Perils of 2010 and Beyond. The Selected Works of Brett T. Bradford. Retrieved from: http://works.bepress.com/brett_bradford/1/.

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