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THE BASIC TAX STRUCTURE: (2) THE ESTATE TAX Having at least broken the ice on the federal gift tax, we turn next to its even more dauntingly glacial companion, the federal estate tax. We will also touch briefly on the Vermont estate tax (Vermont, it will be recalled, does not levy a gift tax - this in contrast, for example, to its neighbor New York, which levies both such taxes). The estate tax is imposed at progressive rates (18% to 55%) on the taxable estate of all decedents who are U.S. citizens or U.S. residents. The estate-tax treatment of nonresident aliens is beyond the scope of this article. U.S. citizens and U.S. noncitizen residents are for the most part treated identically. Their gross estates (the starting point for determining their taxable estates) are made up of the aggregate value of the various items specified in Chapter 11 of the Internal Revenue Code, such value being generally fair market value at death or, at the option of the executor, six months later. The location of the asset in question (i.e., whether it is within or outside the United States) has no bearing on its taxability. The value of virtually every asset is subject to inclusion in the gross estate of a citizen or resident. The assets or interests listed in the tax statute owe their inclusion in the gross estate primarily to one or another of the following: ownership (as it is generally understood - e.g., I buy a house and die with the house in my name); reservation of rights in property which I previously owned but transferred during my lifetime (e.g. - I give my Van Gogh to a museum but one of the terms of the deed of gift is that I am to keep the painting in my possession until I die); reservation of rights of amendment over property which I have placed in trust (e.g., I give money to a trust for a friends benefit but retain the right to revoke the trust or redirect its beneficial interests if my friend is ever convicted of a felony); joint ownership with another person with right of survivorship so that when one of us dies the property becomes the survivors; powers of appointment provided that as holder of such a power I could appoint (direct payment of the underlying property) to myself, my estate or the creditors of my estate (regardless of whether I actually exercise the power); and proceeds of insurance on my own life, provided that at my death I had an incident of ownership with respect to the insurance policy or had divested myself of every such incident within the three years next preceding my death (the commonest incidents of ownership being the right to cash the policy in or borrow against it and the right to change the beneficiary designation). Once the gross estate has been aggregated it then becomes necessary to determine the deductions to which the estate may be entitled: in summary these are made up of debts, funeral and administration expenses; certain gifts to or in trust for the decedents surviving spouse (marital deduction property); and gifts to charity. Perhaps an example may help to illustrate the estate-tax situation for a decedent who dies with a comfortable estate. His name is Michael; he is survived by his wife, Angela, and their two adult children. Michaels gross estate is made up as follows:
The items followed by the symbol (P) are probate property (see Article V); the others are nonprobate property and therefore pass outside Michaels will. For simplicitys sake we will ignore the tax significance of whatever debts Michael may owe at his death and the expenses which will be incurred in his funeral and the administration of his estate. In his will, he leaves his tangible personal property to Angela outright. The rest of his probate assets are left to a nominally funded revocable trust which he set up at the time of his retirement. The following chart may help to illustrate how Michaels gross estate passes (the symbol (M) denotes that the item in question qualifies for the federal estate-tax marital deduction):
Michaels revocable trust will receive the first three items plus the life insurance proceeds, for a total of $1,375,000. All of this is potentially deductible as a marital deduction, in addition to the four items marked (M) aggregating $830,000. However, Michael was quite properly advised to direct that $625,000 of this trust should be set aside in a separate credit shelter trust (see Article VI) for the benefit of Angela and the children and their children, and that only the balance of $750,000 be placed in a marital deduction trust (i.e., a trust for Angelas exclusive benefit during her life and then to the children at her death). In this fashion, there will be no federal estate tax to pay at Michaels death since $1,580,000 will qualify for the marital deduction and the other $625,000 will be nontaxable because it will be covered by Michaels gift/estate-tax exemption in that exact amount. Angelas gross estate when she dies will include the value at that time of (I) the marital deduction trust (ii) the summer home (iii) the IRAs and (iv) the tangibles. Nothing will be included on account of the pension because it will cease at Angelas death. The estate tax, in other words, has been deferred but not necessarily eliminated - unless, of course, Angelas estate (including what she received from Michael) has dwindled to an aggregate amount which does not exceed whatever part of her exemption remains unused at the time of her death. Unlike some states which have death-tax statutes which rival in complexity the federal estate tax, Vermonts estate tax, a relatively simple proposition, is what is commonly referred to as a sponge or sop up tax. A word of explanation may be in order. The federal estate-tax statute allows a credit against the federal tax for death taxes which the estate in question is required to pay to a state. However, the credit may not exceed a fixed amount based on the size of the decedents taxable estate, even if the state death tax actually paid is a greater amount. By way of illustration, if a decedents adjusted taxable estate (the taxable estate less $60,000) is $1,040,000, there is a $38,800 credit for state death taxes actually paid, which will reduce the federal estate tax by $38,800 (the gross federal estate tax on $1,100,000) to $348,000. Those states which employ a sponge tax simply impose a tax equal to the amount of the federal credit. So, if I were to die domiciled in Vermont with the estate just given above, my executor would have a federal estate tax liability of $145,500 (after deducting my $202,500 exemption equivalent credit) and a Vermont estate-tax bill of $38,800, for a total of $184,300. In Michaels case, since he had a zero federal estate tax, there would also be a zero Vermont estate tax liability. The complete list of Christopher Stoneman articles is:
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