Estate Taxes

Reducing Estate Taxes

What most people think of as estate tax is actually a tax system that consists of three distinct taxes on the transfer of assets (in contrast to a tax on income for the sale of consumer goods): estate tax, gift tax, and the generation-skipping transfer tax.

What Is Included in an Estate for Tax Purposes?

A taxable estate includes all assets owned or sufficiently controlled by a decedent, including real and probate property; jointly held, tenants-in-common, or community property; household goods; qualified retirement plans; interests in partnerships or business; trusts; investments including annuities; promissory notes; and, unless special estate planning techniques have been used, proceeds from life insurance policies.

Estate Taxes Defined

Estate tax was the first transfer tax imposed by the federal government. It is a tax on the transfer of assets resulting from someone’s death, such as a mother’s transfer of a home t her children.

Estate taxes are separate from and in addition to the final income tax the decedent must pay. In general, they must be paid within nine months of the date of death and are governed by complex federal rules that change often.

Paying estate taxes can be a challenge if the estate does not have enough liquid assets. In planning for estate taxes, seniors should create enough liquidity to pay their estate tax but not, in turn, cause an increase in it.

Life Insurance Policies

Many people mistakenly believe that life insurance proceeds are entirely tax-free. While they may not be subject to income tax, the proceeds are included in the insured’s taxable estate, unless another individual or entity such as a trust or charitable organization owns the policy on the insured’s life.

Purchasing life insurance to pay for estate taxes requires special planning so the additional life insurance does not increase the size of the estate, and thus estate taxes, in an ever-upward spiral.

To determine the amount of taxes owed on an estate, the personal representative or successor trustee established the fair market value of all the estate’s assets. Once the fair market value is established, certain items are subtracted from it, such as outstanding debts, settlement expenses, charitable donations, and the applicable exclusion amount for estates and gifts. The remainder is the amount on which the estate pays taxes.

The Applicable Exclusion Amount: Estate and Gift Taxes Combined

After the death of a taxpayer, heirs are allowed to exclude a certain amount of the deceased’s assets from taxes on the estate. This amount is called the applicable exclusion amount. It is $ 1.5 million starting in 2004 and increases to $ 3.5 million in the year 2009.

Applicable Exclusion Amount and Gift Tax Rate


Applicable Exclusion Amount*

Highest Gift Tax Rate**


$1.5 million

48 %


$ 1.5 million

47 %


$ 2 million

46 %


$ 2 million

45 %


$ 2 million

45 %


$ 3.5 million

45 %


Estate tax is repealed

Gifts above $ 1 million are taxed at the maximum ordinary individual income tax rate


$ 1 million

55 %

*Includes the $ 1 million lifetime gift exclusion that does not increase.

** Applied to taxable gift amounts in excess of the $ 1 million lifetime gift exclusion.

Of this amount, $ 1 million can be in the form of taxable gifts that the deceased gave to individuals over his or her lifetime prior to death. Although the applicable exclusion amount increase from 2004 through the year 2009, the portion of it that applies to lifetime gifts does not change; it remains at $ 1 million through the year 2009.

Not that use of the gift tax exclusion during life reduces the estate tax exemption available to heirs at death. Here is an example of how the $ 1 million lifetime gift exclusion is used in conjunction with the applicable exclusion amount to determine how much estate tax is owed:

Every year, Marjorie gives her daughter Jeanette a $ 25,000 cash gift, and after using the $ 13,000 annual exclusion every year, Marjorie’s applicable exclusion amount is applied to her lifetime gift tax exclusion of $ 1 million-so every year no fit tax is due on the remaining $ 12,000. After 10 years of these gifts, Marjorie dies. As a result of these fits, the applicable exclusion amount on Marjorie’s estate has been reduced by $ 120,000. Assuming Marjorie died in 2009, her estate has a $ 3.5 million applicable exclusion amount. The remaining applicable exclusion amount I $ 3.38 million. Marjorie’s heirs can deduct $ 3.38 million from her taxable estate. Because Marjorie’s estate is valued at $ 1 million, her heirs pay no estate tax.

The information above is reprinted from Working with Seniors: Health, Financial and Social Issues with permission from Society of Certified Senior Advisors® . Copyright © 2009. All rights reserved.