On a daily basis I have to turn complicated tax issues into a simple discussion. A discussion that I have to discuss/teach very often is the Federal Estate Tax. Before we discuss the easy way to determine your Federal Estate Tax bill some caveats:
- The calculations below are commonly referred to as “Napkin Math.” Meaning, it is simplified and thus can be done on the back of a napkin. We are not using exact numbers, exact deductions, exact credits, etc. Rather, I am providing tools to understand what the Federal Estate Tax actually is, and how it affects people.
- Second, I am not dealing with State Estate Taxes (Yeah bet you didn’t know that your state may have one!). There are 18 states with separate Estate Taxes, known as Decoupled States. We will talk about them in another post.
- Third, this post is not meant to start a fight about the Estate tax (or when used as political rhetoric – Death Tax), but rather educate how the current system works.
- The number we we come up with – is due and owing within 9 months from date of death, in cash. The government has no interest in property – leads to a huge amount of liquidity issues that we will discuss in a different post (again, this a generality, the government allows farms and small businesses to extend their payment).
- Before completing your 706 form – also unofficially known as your LAST TAX RETURN EVER – speak with a qualified attorney or CPA (but from my experience, most CPAs know very little about this area).
Phew, with all those caveats out of the way lets get down to “work”!
Calculating your Estate Taxes
First we need a person’s Gross Estate, i.e. everything they own. If it is owned jointly then we will use one-half of that value (this may be different in community property states but there are only 9 of you and no where near my state so I am going to ignore you guys for now). Also when we take the gross estate – we have to minus an liabilities owed on that asset. Once we have that Gross Estate we then minus the Credit Shelter Amount. The Credit Shelter Amount is (simply put) a coupon that the government gives you; it allows you to pass that amount of assets to a non-marital U.S. Citizen beneficiary. This year a decedent can pass $2,000,000 tax free; in 2009 that number is $3,500,000, in 2010 it is unlimited; and then in 2011 we are back down to $1,000,000.
After we minus the Credit Shelter Amount, we have the Taxable Estate. We then minus any assets given to a spouse (Marital Deduction) or given to a charity (Charitable Deduction). This Taxable Estate is then multiplied by 50%, remember, we are using napkin math! The number you come up with is your Net Taxes owed.
THAT’S IT FOLKS – How do I do all this on the back of napkin? It is this easy:
-Credit Shelter Amount
THIS IS THE AMOUNT OWED TO THE U.S. GOVERNMENT
We have Mr. Chauvinistic – He owns EVERYTHING in his family. His assets include $10,000,000 Taxable Portfolio (i.e. not qualified money), and a home worth $4,000,000 (no mortgage – remember napkin math). So lets get to it.
– (Credit Shelter Amount) $2,000,000
– (Marital Deduction) Everything goes to the Wife
– (Charitable Deduction)ZERO
(Taxable Estate) 0
What happened here? He left $14,000,000 but owed no taxes? Simple – his Marital Deduction covered everything! However, now Mrs. Chauvinistic dies
(Assets) $14,000,000 (ignore growth for now)
-Credit Shelter Amount$2,000,000 (she dies this year after the heart break of losing her husband
This family loses both parents and now has to pay the U.S. Government $6,000,000. I have talked about how to reduce this amount (here) and will continue to do so in future posts.
P.S. Lets look what happens to the same numbers 2011:
Assets$14,000,000 (ignore growth for now)
-Credit Shelter Amount $1,000,000 (she dies this year after the heart break of losing her husband)
AN EXTRA $500K!
Any questions or comments?!