BASIC ESTATE TAX CONCEPTS

The federal government imposes an estate tax on U.S. individuals. Actually, the estate tax system is a combined estate and gift tax system.  Whereas estate taxes are assessed on property passing as the result of a person’s death, gift taxes are assessed on any property which is given away during a person’s life.  The two taxes work together so that a person cannot give away property during his or her lifetime in order to avoid the estate tax at death.

Now, the best way to briefly explain the estate tax is to concentrate on three major principles:

  1. The gross estate
  2. The marital deduction
  3. The applicable credit amount.

The Gross Estate.

The starting point for discussing the impact of estate taxes is a person’s gross estate.  In other words, the estate tax is assessed on a person’s gross estate, after taking into account certain allowable deductions.  A person’s gross estate includes the value of all property which passes as a result of a person’s death.  Accordingly, it includes any property owned by a person outright at death; i.e., property in solely that person’s name.  These are the items that are controlled by a person’s will; i.e., the property in a person’s probate estate. And, by property, I mean any assets.  The term property includes cash, bank accounts, stocks, bonds, real estate, and other investments.  It also includes tangible personal property like cars, furniture, clothing, jewelry, and other personal effects.

The gross estate also includes certain property which is not included in a person’s probate estate.  Many people incorrectly believe that, if property is not included in a person’s probate estate, that property is likewise not included in the person’s gross estate, and is thus exempt from estate taxes. Nothing could be further from the truth.

For example, the gross estate includes a portion of any property owned jointly with survivorship. Typically, jointly owned property passes automatically to the surviving joint owner at a joint owner’s death. It is thus excluded from a person’s probate estate, and likewise is not controlled by a person’s will.  But, because it constitutes property which passes as a result of a person’s death, it is still subject to estate taxes. The general rule is that a person’s gross estate includes ½ of any property owned jointly by that person and his or her spouse.  For property owned jointly between non-spouses, special rules apply (which will not be discussed now).

The gross estate also includes the value of any property passing by contract as a result of a person’s death. The first example that comes to mind is life insurance.  Under a life insurance policy, the insurance company is obligated under the insurance contract to pay the proceeds to the named beneficiary upon the insured’s death.  Therefore, if a person has named his spouse as beneficiary of a life insurance policy, upon the person’s death, the insurance company pays the proceeds directly to the surviving spouse.  The proceeds do not pass through the person’s probate estate, and thus are not controlled by the person’s will.  But, because the proceeds still constitute property which transfers as a result of the person’s death, the full amount of the proceeds is included in the person’s gross estate.  (Please note that the full face amount of the insurance (the death benefit) is included, and not the cash surrender value.)  Other examples of contractually controlled property which are included in a person’s gross estate, even though they do not pass through the probate estate, are retirement accounts, IRA’s, 401(k) accounts, and P.O.D. accounts.

The Marital Deduction.

Once you have arrived at the value of a person’s gross estate, you are allowed certain deductions and credits.

The most important deduction in the estate tax system is the marital deduction.  In essence, anything that passes to a person’s spouse at death passes free of estate taxes.  Actually, you deduct from the gross estate the value of any property which passes to the surviving spouse, but the result is the same.  For example, if the only asset owned by a person at death is a $3 million bank account, and this bank account passes as a result of the person’s death to his or her spouse, then the gross estate would total $3 million.  But, this amount would be totally offset by the unlimited marital deduction, resulting in an estate tax of zero.

An important aspect of marital deduction is that it does not eliminate the estate tax but merely postpones the estate tax, essentially until the death of the surviving spouse.  In the above example, the $3 million bank account passed free of estate tax under the marital deduction, because it passed to the surviving spouse.  But, at that time, the surviving spouse owns the $3 million account, and the account will be subject to estate tax at the surviving spouse’s death to the extent that the spouse does not spend it before his or her death.

The Applicable Credit Amount.

Another important provision in the estate tax system is the applicable credit amount.  This is actually a $2 million exemption.  This means that the first $2 million of assets in a person’s estate pass tax free.  Or, stated another way, if a person’s taxable estate is less than $2 million, then no estate taxes are due.

By the way, this applicable exemption amount is slated to increase to $3.5 million in 2009. However, there is no guaranty that this phase-in will still take place.  There is actually a possibility that the exemption will be increased.


We hope that the above discussion has brought to light many of the issues which must be addressed in the estate planning process. It is intended for informational purposes only and to assist a client in his or her general understanding of the estate planning process. We do not intend for this to be an exhaustive discussion of all issues involved.  Nor do we intend for this information to be a substitute for legal advice.  However, if you have any questions about any of the above information, or if you need additional assistance with your estate planning, please feel free to contact us.