October 18, 2019

The estate tax applies to property transferred by a will or other probate proceedings. Congress has set extensive limitations on who is obligated to pay estate tax. The most recent tax reform bill, enacted in 2017, more than doubled the size of estates that are excluded from estate tax liability. A handful of states have enacted their own taxes on estates or inheritances, but California is not among them. Even if a person does not expect their estate to be large enough to incur an estate tax liability, understanding how the tax works is an important part of estate planning.

What Is the Estate Tax?

The Internal Revenue Code (IRC) defines the estate tax as a tax on “the transfer of the taxable estate of every decedent who is” a U.S. citizen or resident. The executor of the estate is responsible for paying the tax.

The tax is calculated as a percentage of the value of the non-exempt part of an estate. Tax rates start at eighteen percent for values of $10,000 or less. For a value of more than $1 million, the amount of tax is $345,800 plus forty percent of the amount in excess of $1 million.

These rates only come into play if the total value of the estate is greater than the amount excluded by law from taxation. As mentioned, that number is quite large. Even if an estate is large enough for the estate tax to apply, other exemptions or adjustments are possible, such as for gifts made by the decedent.

What Is the Unified Credit Against Estate Tax?

Section 2010 of the IRC establishes a unified credit to be applied against an estate’s tax liability. The credit is essentially equal to the amount of tax owed if the estate’s value is equal to or less than the “applicable exclusion amount.” This amount is equal to the sum of the “basic exclusion amount” set by statute, and the “deceased spousal unused exclusion amount.” The IRS has the authority to adjust the basic exclusion amount each year to account for cost-of-living adjustments. Prior to 2018, the basic exclusion amount, absent any IRS adjustments, was $5 million, meaning that any estate valued at less than that amount most likely had no estate tax liability.

The Tax Cuts and Jobs Act of 2017 made major changes to the estate tax. Section 11061 of the bill amended the IRC to double the basic exclusion amount from $5 million to $10 million. The law went into effect at the end of 2017. In late 2018, the IRS announced that the basic exclusion amount for anyone who dies in 2019 would be $11.4 million.

How Is the Gift Tax Involved?

The gift tax, according to the IRC, is a tax “on the transfer of property by gift.” The IRC allows an annual exclusion of $10,000 in gifts, subject to cost-of-living adjustments. For 2019, the annual gift tax exclusion is $15,000.

The total amount of gift tax exclusions used over a person’s lifetime is relevant to the estate tax. A person’s lifetime gift tax exclusion is deducted from the applicable credit amount applied to their estate tax liability. In other words, making tax-exempt gifts could reduce a person’s eventual exemption amount for estate tax purposes. This still only applies, at least in 2019, to estates worth more than $11.4 million.

If you have questions about a tax issue, the Enterprise Consultants Group’s California tax advisors are available to assist you. Please contact us today online or at (800) 575-9284 to schedule a free consultation.