The Federal Estate Tax ('Estate Tax') and the Federal Gift Tax ('Gift Tax') are both transfer taxes. The Gift Tax taxes the amount of wealth transferred by a donor during life, while the Estate Tax taxes the amount of wealth transferred by a decedent at the time of his or her death. An overview of each tax and an explanation of how the taxes are interrelated is provided below.
Federal Estate Tax
The Estate Tax is a transfer tax, which taxes the amount of wealth transferred by a decedent at the time of his or her death. The amount of the tax owed is actually determined using a formula, which includes some technical terms defined in the Internal Revenue Code. This formula can be broken down into three parts. The first part of the formula is: Gross Estate less Liabilities and Deductions equals Taxable Estate. The second part is: Taxable Estate times Tax Rate equals Tentative Tax. The third part is Tentative Tax less Applicable Credit Amount (formerly known as the 'Unified Credit') equals Tax Payable. Each part of this formula is described below.
Gross Estate
The first step in determining the amount of Estate Tax due is to determine the Gross Estate. The Gross Estate includes the value of all property owned by the decedent at death which passes to someone else by their Last Will and Testament or by intestacy, as well as some life insurance proceeds and some jointly-owned property. The amount of Adjusted Taxable Gifts is also included in the Gross Estate. The Adjusted Taxable Gifts are all of the taxable gifts made during the decedent's lifetime after December 31, 1976. In addition, the Gross Estate may also include some property gifted by the decedent prior to the decedent's death if the decedent retained certain controls or 'strings' over the property. Thus, the Gross Estate may include property which is not part of the decedent's 'probate estate.'
Deductions
The next thing that must be determined is what Deductions may be subtracted from the Gross Estate. Such Deductions may include the marital deduction, charitable deduction, and certain expenses. The decedent's Liabilities are also subtracted from the Gross Estate. After Liabilities and Deductions are subtracted from the Gross Estate, the resulting amount is known as the Taxable Estate.
Tax Rate
Next, the Taxable Estate is multiplied by the Tax Rate. The Tax Rate is determined by the Internal Revenue Code, and can be as high as 55%. After this calculation is made, the resulting number is the Tentative Tax.
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