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Introduction to Estate Tax Law

An individual's “estate" is everything they own. As a measurement of the individual's wealth, it is analogous to their net worth (i.e., the total value of their property minus debt). Their property may include:

  1. Personal property (e.g., vehicles and jewelry),
  2. Real property (e.g., buildings and land), or
  3. Intangible property (e.g., bank accounts, stocks, and patents).

Particularly large estates must sometimes pay estate taxes when the owner dies. This article explores the basic features and background of estate taxes in the United States. It concludes with a list of fast facts that illustrate the complexity of estate tax law.

Basic Concept and Law

Estate taxes are often discussed alongside inheritance taxes. These are sometimes referred to collectively as “death taxes." An estate tax is collected directly from a deceased person's estate before it is distributed. By contrast, an inheritance tax is collected from individuals who receive a portion of an estate after it has been distributed.

There is no federal inheritance tax, only an estate tax. The Internal Revenue Service (IRS) describes the estate tax as “a tax on the right to transfer property at death." There is also a federal gift tax and generation-skipping transfer tax. For more on these, see Federal "Death Taxes" FAQ.

Large estates may face a federal estate tax rate between 18-40% when the owner dies. However, very few estates actually need to file an estate tax return with the IRS. This is because the federal estate tax exemption is currently set at over $12 million, meaning that your estate is not taxable if its total value is less than this amount.

That said, estates below this value may still be required to pay state-level taxes. Exemptions vary according to state law. Twelve states (plus the District of Columbia) currently collect an estate tax: Connecticut, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Vermont, and Washington. Additionally, the following states collect an inheritance tax: Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania.

Estate Taxes: A Brief History Lesson

In one form or another, estate and inheritance taxes have existed for a long time. According to the IRS:

“Taxation of property transfers at death can be traced back to ancient Egypt as early as 700 B.C. Nearly 2,000 years ago, Roman Emperor Caesar Augustus imposed the Vicesina Hereditatium, a tax on successions and legacies to all but close relatives."

Taxation of a deceased person's property is nothing new.

In the early United States, this kind of tax was typically imposed by the federal government in times of war. Federal death taxes have been imposed four times:

  • The Stamp Tax of 1797. Needing to build up the Navy in response to an undeclared war with France, the federal government sought to increase revenue through a tax on federal stamps. These revenue stamps were necessary for various aspects of estate distribution (e.g., probating wills and issuing letters of administration). Once the crisis ended in 1802, the tax was repealed.
  • The Tax Act of 1862. The huge cost of the Civil War led to a reinstatement of federal death taxes. In addition to taxing administrative paperwork, the federal government also imposed a tax on inherited personal property. As the war raged on, it began to tax inherited real estate as well. Once the war ended, the taxes were phased out by 1872.
  • Estate Tax of 1898. Though short-lived, the breakout of the Spanish-American war prompted Congress to revive the federal death tax. However, where previous taxes were imposed on paperwork and inheritances, the 1898 tax was imposed directly on estates. It was repealed in 1902.
  • The Revenue Act of 1916. In need of revenue in the wake of World War I, cash-strapped Congress again began taxing decedents' estates. This tax still exists today, making it the longest-lived federal death tax.

For more history, see The Estate Tax: Ninety Years and Counting (IRS, 2007) and Federal Taxation of Inheritance and Wealth Transfers (IRS, 1998).

The Estate Tax Debate

Taxing a deceased person's property has long been controversial. Through the end of the Civil War, these taxes were only imposed in times of national crisis. As the crisis subsided, so did death taxes.

This changed with the estate taxes introduced in 1898 and 1916, which were driven in large part by a desire to reduce the extreme wealth inequality caused by post-Civil War industrialization. As famous tycoons like John D. Rockefeller and Andrew Carnegie accumulated vast fortunes, their workers often languished in poverty. Therefore, in addition to funding wars, the modern estate tax was also implemented to even out the field.

Whether ideological, moral, or practical, many of the old arguments in this polarized debate still resonate today. One side's argument often feels like a tit-for-tat inverse of the other's. The following table explores corresponding arguments from each side.

Topic

Arguments Against Estate Taxes

Arguments In Favor of Estate Taxes

1. Double Taxation

Acquired assets are already taxed when acquired. They should not be taxed twice.

Acquired assets that are never resold but appreciate in value (i.e., unrealized assets) should be taxed when the owner dies.

2. Meritocracy & Individualism

People should not be taxed for accumulating wealth through their individual efforts.

Wealth should be accumulated through individual effort, not inherited fortunes.

3. Wealth Inequality

Families should not be penalized for passing on their legally acquired wealth.

When uncontrolled, multigenerational wealth accumulation entrenches unfair economic, social, and political advantages.

4. Discrimination, No. 1

It is not fair to single out the wealthy simply for being wealthy.

Wealth building relies on collective economic activity. Therefore, wealth builders should pay back proportionately into the collective.

5. Discrimination, No. 2

It is not fair to single out the wealthy simply for being in the minority.

Tax exemptions ensure that very few people pay estate taxes.

6. Work Ethic

The government should not police individual work ethics. Further, accumulated fortunes allow heirs to engage in other beneficial activities (e.g., creative arts and politics).

Accumulated fortunes disincentivize heirs to be economically productive individuals.

7. Charity

Multigenerational fortunes encourage charitable giving.

Charitable giving is often used as a mechanism to avoid estate taxes.

8. Foreign Wealth Transfer

Estate taxes encourage wealth transfer to other nations.

Many other nations also impose an estate tax.

9. Farms and Small Businesses

Estate taxes disproportionately impact farms and small businesses.

Tax exemptions ensure that very few farms and small businesses are disproportionately impacted.

Fast Facts: 10 Things to Know About Estate Taxes

Governing tax rules are quite complex. The following list illustrates some of the many nuances of estate tax law in the United States.

  1. Very Few People Pay Estate Taxes. According to the IRS, less than 0.2% of the deceased adult population was required to pay the federal estate tax in recent years.
  2. Percentage of Federal Revenue. According to the Congressional Budget Office, the federal estate, gift, and generation-skipping transfer taxes generally account for 1-2% of federal tax revenue each year.
  3. “Pick-Up Taxes." Also known as “sponge taxes," these state-level taxes allowed states to skim a portion of federal estate tax revenue for themselves without raising individual taxpayer bills. As a result of the Economic Growth and Tax Relief Reconciliation Act (2001), these taxes were phased out entirely by 2005, prompting a handful of states to begin taxing estates directly.
  4. No Estate Tax in 2010. Starting in 2001, Congress began gradually phasing out the federal estate tax. By 2010, there was no estate tax at all. However, the estate tax was reinstated the following year and continues today.
  5. Basic Exclusion Amount (BEA). An important component of the federal estate and gift tax exemption is the BEA. The BEA is first applied to any taxable gifts, and the remainder is then applied to the taxable estate. From 2018 to 2025, the BEA is temporarily raised to approximately $11 million. In 2026, the exemption amount will revert to $5 million.
  6. Deduction for Married Couples. The unlimited marital deduction allows a deceased spouse to leave their entire estate to their surviving spouse tax-free, as long as the survivor is a U.S. citizen. The property must pass “outright" (i.e., completely) to the survivor. The survivor's estate will then be subject to the federal estate tax upon their own death. For more on this, see The Marital Deduction Trap and How To Avoid It.
  7. “Fair Market Value." For tax purposes, an estate's valuation is based on the “fair market value" of everything in it. The IRS provides the following, open-ended definition: “The fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts."
  8. Taxable Estate vs. Probate Estate. A probate estate includes all assets titled under the decedent's name on their date of death. A taxable estate includes everything owned or controlled by the decedent on their date of death even if they do not hold title (e.g., assets in a revocable trust). The IRS makes clear that a taxable estate “will likely include non-probate as well as probate property."
  9. Revocable vs. Irrevocable Trusts. Trusts are commonly used for estate and tax planning. Trusts may be “revocable" (changeable by the creator) or “irrevocable" (unchangeable by the creator). Again, because the creator retains some control over a revocable trust, the trust assets are still part of their taxable estate.
  10. Charitable Remainder Trust (CRT). One method of reducing estate taxes is to leave assets to a charity through a CRT, a kind of irrevocable trust. The trust creator can receive income from the trust fund while they are alive by naming themselves as a beneficiary. Once they die, the trust assets avoid the estate tax. Further, if the charity sells the assets, it also avoids the capital gains tax.

Have Legal Questions? An Attorney Can Help.

So-called “death taxes" are as persistent as they are controversial. This area of tax law can be quite complex. Whether you are exploring tax planning strategies or are uncertain whether a deceased loved one's estate should file a federal estate tax return, a local tax or estate planning attorney can help.

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