5.20

Estate Taxes

References
See Also

7.04   Gift Taxes

Standard Exceptions

DEC   Decedent's Estates

FTL   Federal Tax Liens

JOT   Joint Tenancies

Bulletins

SLS2013002   Foreign Investment in Real Property Tax Act (FIRPTA)

5.20.1

In General

The federal estate tax is a transfer tax. It is a tax on the right to transfer property at death, not a tax on the property itself. However, the tax is measured by the value of the property or property interests transferred.

The federal estate tax reaches the value of property owned by the decedent since a transfer of the Decedent's property takes place at the time of death. However, the tax is also imposed upon certain gratuitous transfers that the decedent may have made.

Transfers of property during life may also be subject to the federal gift tax, and since the two taxes are not uniform as to what constitutes a completed gift, they sometimes overlap.

The estate tax can be a major risk, since the amount of tax on a large taxable estate can be significant. For example, the marginal estate tax rate over $3,000,000 is currently 55%.

The federal estate tax is distinguished from an inheritance tax.

Many state death taxes are inheritance taxes. An inheritance tax is a tax on the right to receive property from a decedent. It is based on the value of each beneficiary's share, with exemptions and rates varying, depending upon the relationship of the beneficiary to the decedent. The estate tax, on the contrary, is a tax on an individual's right to transfer property at death and is based upon the value of the taxable estate as a whole.

5.20.2

Steps Involved In The Determination Of The Federal Estate Tax

The determination of the federal estate tax involves four major steps:

  • Deciding what property is to be included in the gross estate.
  • Valuing the property included.
  • Applying allowable deductions in arriving at the taxable estate.
  • Computing the tax.

5.20.3

Computation Of The Federal Estate Tax (Applicable To Estates Of Decedents After 1981)

The estate tax is imposed on the transfer of the taxable estate. The taxable estate is the gross estate less allowable deductions.

The following illustrates the steps in computing the federal estate tax:

Gross Estate

Less: Deductions for expenses, debts, and losses.

Equals: Adjusted gross estate.

Less: Marital deduction (property which passes to a surviving spouse pursuant to 26 U.S.C. 2056) and charitable, religious and public use deductions.

Equals: Taxable estate.

Plus: Adjusted taxable gifts.

Equals: Estate tax computation base.

The unified rate schedule is applied to the estate tax computation base.

Equals: Tentative estate tax.

Less: Post-1976 gift taxes paid, unified credit, state death tax credit, and other credits allowed.

Equals: Estate tax payable.

5.20.4

Includible Items In A Decedent's Gross Estate

The gross estate consists of the value of:

  • Property owned by decedent at death.
  • Dower and curtesy interests.
  • Gifts within three years of death.
  • Gifts with life interest retained.
  • Gifts taking effect at death.
  • Revocable transfers (such as trusts subject to change through exercise of a power).
  • Annuities.
  • Joint interests (except prior interest of other joint owner).
  • Power of appointment.
  • Proceeds of insurance.
  • Transfers for insufficient consideration.
  • Certain marital deduction property.
  • Community property (to the extent of the decedent's interest)

See 26 U.S.C. Section 2031-2046.

5.20.5

Valuation Of The Gross Estate

General Rule

Property is generally included in the gross estate at its fair market value at the date of the Decedent's death. I.R.C. section 2031. Fair market value means the price at which the property would change hands between a willing seller and a willing buyer.

Alternate Valuation Date

At the executor's election, the gross estate may also be valued at its fair market value on the alternate valuation date. I.R.C. section 2032. The alternate valuation date is generally the date six months after death. If property was sold or disposed of during the six-month period, it is valued as of the date of disposition.

The election to use the alternate valuation date may be made only where both the total value of all property in the gross estate and the federal estate tax liability of the estate are reduced by making the election. It is not possible to use the alternate valuation election to pass property with a higher basis to an heir or beneficiary. If lower, the date-of-death value must be used. However, if the value of property declines due merely to the passage of time (e.g., an annuity), the date-of-death value must be used. I.R.C. section 2032(a)(3). Similarly, where a decline in value was due to the automatic renewal of a lease, this decline could not be reflected in a lower alternative valuation because the decline had resulted from voluntary acts, not market conditions.

The Code permits the alternate valuation election to be made irrevocably on the first estate tax return (whether filed timely or late), provided the return is filed no more than one year after the due date. An untimely election for alternate valuation is invalid. I.R.C. section 2032(d).

Valuation of Farm and Business Realty

"Qualified real property" used for farming or in a closely held business presents an exception to the "fair-market-value" rule applicable to valuing the gross estate.

Generally, real property is valued on the basis of its "highest and best use," which typically sets the upper limit of the property's value. A "current use" approach is available for qualified real property used for farming purposes or in certain trades or businesses under the following conditions:

  • At the time of death, the decedent must have been a citizen or resident of the United States.

  • The executor specifically elects to have the special valuation rules apply and files an agreement executed by all parties with an interest in such property. I.R.C section 2032A(a).

5.20.6

Credits That May Be Taken Against The Tax

After the federal estate tax is computed, the following credits may be taken against the tax:

  • Unified credit.
  • Credit for state death taxes.
  • Gift tax credit.
  • Credit for estate tax on prior transfers.
  • Credit for foreign death taxes

    26 U.S.C. Sections 2010-2016.

5.20.7

The Unified Credit and Applicable Exclusion

The unified credit is a dollar allocated to each tax payer which can be applied against the gift tax and the estate tax. If the taxable estate is less than this amount, not estate tax should be owed. The phasing in is as follows:

Decedents Dying in (or Gifts Made in) Applicable Exclusion Amount

1982 $225,000
1983 275,000
1984 325,000
1985 400,000
1986 500,000
1987 through 1997 600,000
1998 625,000
1999 650,000
2000 and 2001 675,000
2002 and 2003 700,000
2004 850,000
2005 950,000
2006 or thereafter 1,000,000

See 26 U.S.C. Section 2010.

5.20.8

Filing Of A Tax Return And Payment Of The Tax

A federal estate tax return, if required, must be filed and the tax paid by the Decedent's executor, administrator, personal representative, or person in actual or constructive possession of the property within nine months after the Decedent's death. IRC sections 6018(a), 6075(a), and 6151(a). Whether or not a return is required depends on the size of the gross estate, the year of death, and possibly also on what kinds of gifts were made by the decedent before death. Generally, an estate tax return must be filed if the gross estate exceeds the applicable exclusion amount (shown in 5.20.7 above) for the year of the death of the decedent.

Company Policy: If the gross (not net) estate does not exceed the above amounts for filing as established by inventory or credible affidavit, you may assume no federal estate taxes are owed.

5.20.9

State Inheritance And Estate Tax Liens

In addition to the federal estate tax, most states impose an inheritance, or estate tax, or both, or some other type of legacy or succession tax. A few states also impose a state gift tax.

State Inheritance Taxes

When a state imposes an inheritance tax, it is usually imposed upon the right to receive real property and tangible or intangible personal property which is transferred by will or intestate succession, or by deed, grant or gift made in contemplation of death. Often any such transfer made within a short period (defined statutorily) before the Decedent's death will raise a presumption that it was made in contemplation of death.

The inheritance tax thus imposed is generally computed by applying a graduated rate which varies according to the total value of the taxable property and the relationship of the transferee to the decedent.

It is important to note that many states impose both an inheritance and estate tax. In such states, the estate tax is often computed as a sum equal to the amount by which the Federal Credit allowed by the Federal Revenue Code exceeds the total estate, inheritance, legacy, transfer, and succession taxes actually paid to the states or territories of the United States in respect to the estate of the decedent.

State Estate Taxes

Estate taxes are imposed by a majority of the states and are generally computed with reference to the maximum credit allowed under federal law. A typical provision might declare that, in the case of a resident of the state, the estate tax is a sum equal to the Federal Credit allowable under 26 U.S.C. Section 2011 for state death taxes.

State Gift Taxes

Some but not all states impose a gift tax upon donative transfers.

Lien for State Inheritance, Estate, or Gift Taxes

In the case of estate taxes, the liability for taxes falls upon the residuary estate, and in the case of inheritance taxes, upon the transferee, in the absence of statutory or testamentary provisions to the contrary.

When such taxes remain unpaid by the obligor, many states impose a lien on the property, including real property, which has passed.

There is a modern trend toward subjecting claims for inheritance, estate, or gift taxes by a state to its statutes of limitations. A check of the state statutes must be made to establish whether the claim for taxes by the state (and therefore the lien) may be considered as barred by the lapse of time.

5.20.10

Federal Tax Liens For Estate Taxes

There are basically two categories of tax liens available to the federal government for the enforcement of federal estate taxes:

  • The general federal tax lien or assessment lien, 26 U.S.C.A. sections 6321 to 6323. See Federal Tax Liens. (6.08)
  • The special federal tax lien which may be subcategorized as follows:

    • Special lien for estate taxes. 26 U.S.C.A. section 6324(a).

    • Special lien for estate taxes deferred under section 6166, for which no refiling of notice of estate tax lien is required. 26 U.S.C.A. section 6324A.

    • Special lien for estate taxes attributable to qualified property, for which no refiling of notice of estate tax lien is required. 26 U.S.C.A. section 6324B.

This special federal estate tax lien under 26 U.S.C. section 6324 attaches, as of the date of death, to all property constituting the gross estate of the decedent and, unlike the income tax lien, attaches without assessment of or demand for the tax due. The lien attaches to property of the decedent irrespective of whether that property comes into the hands of the executor or administrator. The lien exists for 10 years from date of death, without any necessity of filing of a notice of tax lien. A separate notice of lien may be filed and thereby extend the time for an effective tax lien.

Any estate tax that is due constitutes a lien at the date of the Decedent's death and continues for a period of ten years (fifteen years under 26 U.S.C.A. section 6324B unless the tax is paid); however, the life of the lien may be extended. Since no assessment or demand is necessary for the creation of a "special" federal estate tax lien, this tax lien does arise before the filing of the "general" federal estate tax lien. The special lien for estate taxes established in 26 U.S.C.A. section 6324 is essentially a hidden lien for a period of 10 years from date of death of the decendent (except to the extent one has knowledge of the death of the decedent) and remains secret for the duration of its validity, there being no applicable recording requirements.

However, 26 U.S.C.A. section 6324A does establish some filing requirements for those estate taxes deferred under section 6166. In addition, 26 U.S.C.A. section 6324B also establishes the same filing requirements for those estate taxes deferred under section 2032A.

In Detroit Bank v. United States, 317 U.S. 329, 63 Sup. Ct. 297 (l943), it was held that there is less need for protection of third persons by a recorded notice of the lien when the property passing at death is normally dealt with by probate and estate tax proceedings of public notoriety.

In United States v. Vohland, 675 F.2d 1071 (9th Cir. 1981), it was held that the enforcement of an estate tax lien against a bona fide purchaser without notice did not violate the due process clause of the fifth amendment.

Nonresident Aliens-Estate Tax: Nonresident aliens are subject to U.S. estate tax on their taxable assets located in the U.S. They are limited to an exemption of only $60,000. Nonresident aliens can take advantage of the annual gift exclusion, which is $14,000 for 2013, and make gifts of up to $14,000 per donee, which would not be subject to gift tax. If the gift is to a noncitizen spouse, the annual exclusion amount is increased ($143,000 for 2013).

5.20.11

Protection For Certain Interests Of Gross Estate

Lien Under 26 U.S.C.A. section 6324

Inasmuch as the special estate tax lien is not subject to the requirement for filing notice of lien under 26 U.S.C.A. section 6323, as is the general federal tax lien, a purchaser, holder of a security interest, mechanic's lienor, or a judgment creditor who acquires an interest in property includible in the gross estate of a decedent is not protected against a special estate tax lien, except as such protection may be specifically provided by 26 U.S.C.A. section 6324.

Code section 6324(a)(2) provides protection to purchasers and holders of security interests with respect to property includible in the gross estate under sections 2034 through sections 2042, often referred to as "property not subject to probate assets."

Any nonprobate assets transferred by a spouse, transferee, trustee, surviving tenant, person in possession, or beneficiary of the dependent shall be divested of the lien for estate taxes.

Nonprobate assets include the following:

  • Dower or curtesy or interest in lieu thereof. Section 2034.
  • Gifts made within three years of death. Section 2035.
  • Transfers with retained life estates for less than adequate and full consideration. Section 2036.
  • Transfers taking effect at death if not a bona fide sale. Section 2037.
  • Revocable transfers. Section 2038.
  • Certain annuities other than policies of insurance. Section 2039.
  • Survivorship interests such as joint tenancies. Section 2040.
  • Powers of appointment. Section 2041.
  • Proceeds of life insurance. Section 2042.

Lien Under 26 U.S.C.A. Section 6324A

The lien for deferred estate taxes will not be valid as against any purchaser, holder of security interest, mechanic's lienor, or judgment lien creditor until notice has been filed in accordance with 26 U.S.C.A. section 6323(f). Such notice is not required to be refiled.

Lien Under 26 U.S.C.A. Section 6324B

The lien for deferred estate taxes will not be valid as against any purchaser, holder of security interest, mechanic's lien, or judgment lien creditor until notice has been filed in accordance with 26 U.S.C.A. section 6323(f). Such notice is not required to be refiled.

5.20.12

Extinguishment Of Federal Estate Tax Liens

The extinguishment of a federal estate tax lien can be accomplished as follows:

  • By the payment of the tax in full.

  • By the issuance by the Secretary of Treasury or the Secretary's delegate of a certificate of release. (26 U.S.C.A. section 6325(a).

  • By the issuance by the Secretary of Treasury or the Secretary's delegate of a certificate of discharge (as to the property therein specifically described based on sufficient remaining assets, substitution of collateral, or part payment). (26 U.S.C.A. section 6325(b).

  • By the running of the statute of limitations:

    • General federal tax lien - 10 years.

    • Special federal tax lien - 10 years or 15 years, as the case may be. However, this time limit should be relied upon to waive a filed special federal tax lien.

Subordination of the lien is also provided for in title 26 U.S.C.A. section 6325(d).

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