What are the tax consequences of death?

In the administration of any estate of a person who has passed away, there may be significant tax consequences. An estate that consists simply of a marital trans­fer, property being transferred from one spouse to another, normally does not involve any estate tax consequences. Instead, the tax consequences will occur when that surviving spouse passes away. The objective of this tax law provision is to attempt to ensure that the surviving spouse has sufficient assets during his or her life to maintain him- or her­self, but then upon the death of the surviving spouse the estate will be taxed according to the federal estate tax law. There may, however, be state inheritance taxes that must be considered.

Taxation of property transferred by an individual to others at his or her death is one of the oldest and most common forms of taxation. Gift taxes and death taxes in the form of estate or inheritance taxes are generally referred to as transfer taxes. The transfer of property may be in the form of a gift or in the form of a conveyance at the time of death. A federal tax on transfers at death was first employed in the form of an inheritance tax in 1862. At first it applied only to personal property, but later it was extended to real property as well. In order to avoid the federal and state taxes on transfer of property at death, some property owners made large transfers during their life. To counteract this technique (and partly for political reasons) the Federal Gift Tax was enacted in 1924.

The transfer taxes were not enacted merely to raise revenue. In fact, they do not raise much revenue compared to other federal taxes. In part they were designed to prevent people from accumu­lating large blocks of wealth and then transmitting those blocks from generation to generation. Overall the IRS has not been terribly successful in that regard.

In determining federal estate tax liability, the first issue that must be addressed is the gross estate. The gross estate includes, at a minimum, the value of all property owned by the decedent at death that passes to somebody else. This includes some life insurance proceeds and some jointly owned property. The gross estate for tax purposes is not necessarily the same as the estate that might be reported to the local court for probate purposes.

Once the gross estate has been calculated, there are certain allowable deductions that may be taken to arrive at what is referred to as the taxable estate. Those deductions include allow­ances for most transfers to a surviving spouse (the marital deduction), contri­butions to charity, and deductions for certain debts and expenses.

The gift tax is designed to be a com­panion tax to the estate tax. The gift tax applies to any gratuitous transmission of property during a person's life since a transfer of that nature has the effect of reducing the estate subject to estate tax at time of death. There are certain exclusions in regard to the gift tax. For instance, each year a person is entitled to an annual exclusion for gifts in an amount of $11,000 to each donee. Only if the amount given is more than that excludable amount in one year to one donee will the gift be taxable.

Generally, the property transferred from one spouse to another at the time of death is not subject to any estate tax. If the surviv­ing spouse consumes part of what he or she inherited and holds at the time of his or her death an amount less than the estate tax exemption, then he or she will be able to transmit that property outright without a tax on his or her estate because the exemption would apply to that. That exempt amount increases from year to year.

It makes sense to take advantage of that exemption in most instances for each party. In order to do that, each party would have to have an estate at the time of death of as much as the exempt amount. That con be done by of establishing a marital trust.

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