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Supporters of the inheritance tax argue that it is not a death tax per se, but simply a tax on a transfer of wealth. Opponents argue that the tax is applied to the full estate, and not merely the amount transferred, which arguably increases the effective transfer tax rate. In the United States, the tax is imposed only on the "taxable estate," which is generally less than the value of the full estate. If an asset is left to a spouse or a charitable organization, some countries do not apply the tax. The tax is also imposed on other transfers of property made as an incident of the death of the owner, such as a transfer of property from an Intestate estate or trust, or the payment of certain Life Insurance benefits or financial account sums to beneficiaries. ''For UK Inheritance tax, see Inheritance Tax (United Kingdom) . UNITED STATES In the United States, estate and/or inheritance taxes may be imposed at both the national (Federal) level and the state level. Federal estate tax The Federal ''estate tax'' is imposed "on the transfer of the taxable estate of every decedent who is a citizen or resident of the United States." See . The "gross estate" The "gross estate" for Federal estate tax purposes often includes more property than that included in the "probate estate" under the property laws of the state in which the decedent lived at the time of death. The starting point for the calculation of the estate tax is the value of the "gross estate" defined at and , as modified by certain other statutory provisions. The gross estate (before the modifications) may be considered to be the value of all the property interests of the decedent at the time of death. To these interests are added the following property interests generally not owned by the decedent at the time of death:
The above list of modifications is not comprehensive. As noted above, life insurance benefits may be included in the gross estate (even though the proceeds arguably were not "owned" by the decedent and were never received by the decedent). Life insurance proceeds are generally included in the gross estate if the benefits are payable to the estate, or if the decedent was the owner of the life insurance policy or had any "incidents of ownership" over the life insurance policy (such as the power to change the beneficiary designation). Similarly, bank accounts or other financial instruments which are "payable on death" or "transfer on death" are usually included in the taxable estate, even though such assets are not subject to the Probate process under state law. Deductions, the taxable estate, and the tentative tax Once the value of the "gross estate" is determined, the law provides for various "deductions" (in Part IV of Subchapter A of Chapter 11 of Subtitle B of the Internal Revenue Code ) in arriving at the value of the "taxable estate." Deductions include but are not limited to:
After subtracting the deduction amounts from the gross estate amount to arrive at the "taxable estate" amount, the tax rate is imposed on the value of the "taxable estate" to compute the tentative tax. Tax credit, the exemption equivalent, and the tax However, the law then provides for a credit against the tentative tax. The credit may be thought of as providing, in effect, for an "exemption equivalent" or Exempted Value with respect to the value of the property. For a person dying during 2005, an estate with a value less than $1,500,000 would not pay a federal estate tax and most likely would not have to file a federal estate tax return. The applicable exclusion amount increases to $2,000,000 for decedents dying in the years 2006, 2007 and 2008. The amount increases to $3,500,000 for 2009. According to the Econonic Growth and Tax Relief Reconciliation Act of 2001, the federal estate tax disappears for the year 2010, but the tax returns in 2011 at the 2001 level. Requirements for filing return and paying tax For estates larger than the current federally exempted amount, any estate tax due is paid by the Executor or other person responsible for administering the estate. That person is also responsible for filing a Form 706 return with the Internal Revenue Service . The return must contain detailed information as to the valuations of the estate assets and the exemptions claimed, to ensure that the correct amount of tax is paid. Exemptions and tax rates As noted above, a certain amount of each estate is exempted from taxation by the federal government. Below is a table of the amount of exemption by year an estate would expect. Estates above these amounts would be subject to estate tax, but only for the amount above the exemption. For example, assume an estate of $3.5 million in 2005. There are two beneficiaries who will each receive equal shares of the estate. The maximum allowable credit is $1.5 million for that year, so the taxable value is therefore $2 million. Since it is 2005, the tax rate on that $2 million is 47%, so the total taxes paid would be $940,000. Each beneficiary will receive $750,000 of untaxed inheritance and $530,000 from the taxable portion of their inheritance for a total of $1,280,000. This means that they would have paid (or, more precisely, the estate would have paid) a taxable rate of 26.9%.
Inheritance tax at the state level Many U.S. states also impose their own estate or inheritance taxes (see Ohio Estate Tax for an example). Some states "piggyback" on the federal estate tax law in regard to estates subject to tax (i.e., if the estate is exempt from federal taxation, it is also exempt from state taxation). Some states' estate taxes, however, operate independently of federal law, so it is possible for an estate to be subject to state tax while exempt from federal tax. Debate The propriety of the estate tax has been debated extensively. Arguments against Opponents argue that the Federal estate tax rate is effectively higher as a percentage of the amount actually transferred to heirs. For example, an estate worth $3.5 million paid $940,000 federal estate tax in order to transfer $1,280,000 to each heir, suggesting an effective transfer tax rate of 36.7%. Similarly, at the limit, the top federal tax rate of 50% on the estate value would imply a transfer tax rate of 100% of the amount transferred to heirs. The high effective transfer tax rate has prompted many wealthy benefactors to make sizable gifts during their lifetime, paying a Gift Tax on the amount transferred, rather than allow the whole amount to be taxed at the estate level. Some argue that the estate tax creates a potential for double taxation, that is, taxation on assets which have already been taxed. Double taxation occurs on earned income, but not the unrealized capital appreciation of Houses , Farms , Stock s, Bond s, Real Estate , and Collectibles such as works of art. FactCheck.org cites a 2000 study of 1998 estate taxation, which determined that unrealized capital gains made up 36.3% of the value of all estates in 1998, and 56.4% of estates worth more than $10 million (but without taking into account yearly increases of inflation). The debate sometimes revolves around which estates are affected by current law. The effects of the law on small business owners and family-owned farms (entities which, conservatives argue, are hardest hit by the estate tax) was studied in an analysis undertaken by the Tax Policy Center. A study of the 18,800 taxable estates taxed in 2004 found 7,090 which had any farm or business income. Of those, there were 440 estates in which half or more of its assets were the value of farms and/or businesses. The effective tax rate on the 440 estates studied in detail never averaged more than 23%.
Arguments in favor Proponents of the estate tax argue that it serves to prevent the perpetuation of wealth, free of tax, in wealthy families and that it is necessary to a system of Progressive Taxation . Proponents point out that the estate tax only affects estates of considerable size and provides numerous credits (including the unified credit) that allow a significant portion of even large estates to escape taxation. Regarding the tax's effect on farmers, proponents counter that this criticism is misguided as there is an exemption built into the law that is specifically designed for family-owned farms. (According to the Center on Budget and Policy Priorities, "The American Farm Bureau Federation acknowledged to the New York Times that it could not cite a single example of a farm having to be sold to pay estate taxes." {Link without Title} .) Furthermore, supporters argue that many large fortunes do not represent taxed income or savings, that wealth is not being taxed but merely the transfer of that wealth, and that many large fortunes represent unrealized capital gains which with a Step Up In Basis , will never be taxed as capital gains under the federal income tax. Some even go further and suggest all transfers should be taxed, and that the large bequests to family foundations or private charities should be taxed and more heavily regulated. Effects of the debate Many of its opponents refer to the estate tax as the " Death Tax " and have called for its abolition. In response, Congress has passed tax laws that have changed the estate tax. Since 2003 , the top rate has been lowered from 50% by one percentage point per year; in 2006 the top rate was 48%. If the US Congress makes no changes to US tax law, the top rate will continue to drop by one percentage point per year until 2009 when the top rate is scheduled to be 45%; in 2010 all estates will be taxed at 0%; and in 2011 the estate tax will return at a top rate of 50%. Most experts expect that Congress will change the tax law before then: legislation to extend the abolition of the estate tax indefinitely has been introduced. Related taxes The US also imposes a gift tax, assessed in a manner similar to the estate tax. One obvious purpose is to prevent a person from easily avoiding paying estate tax by giving away all of their assets during their lifetime. However, an exemption is available for transfers of up to (as of 2006) $12,000 per person per year. An individual can make gifts up to this amount to as many people as they wish each year, and a married couple can make gifts up to twice that amount, without incurring gift tax. If an individual or couple makes gifts of more than the limit, gift tax is incurred. The individual or couple has the option of paying the gift taxes that year, or to use some of the "unified credit" that would otherwise reduce the estate tax. In some situations it may be advisable to pay the tax in advance to reduce the size of the estate. But in many instances, an estate planning strategy is to give the maximum amount possible to as many people as possible to reduce the size of the estate (the effectiveness of this strategy is based on how long it can continue as obviously it can't continue past death). Furthermore, transfers (whether by bequest, gift, or inheritance) in excess of $1 million may be subject to a Generation-skipping Transfer Tax if certain other criteria are met. FURTHER READING
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