The federal estate tax is imposed on estates that exceed a certain amount in assets. This amount is being increased each year through 2006. Currently, an estate exceeding $675,000 in assets is subject to the federal estate tax. This dollar amount will have increased to $1,000,000 by 2006.
The federal estate tax begins at a rate in excess of 30%, and increases to 55% of your total taxable estate. For instance, an estate with $1,000,000 of net taxable assets should expect to pay $115,000 in estate taxes. An estate of $5,000,000 will owe over $2,000,000.
How are death taxes paid?
There are several methods which an estate can use to pay the death taxes. The executor can borrow the cash. This of course only defers the problem. The taxpayer may pay in cash. Of course, people rarely accumulate large sums of cash. Even if the taxpayer has accumulated this large amount of cash, they will have to forego other profitable investment opportunities. The taxpayer can also liquidate current investments. But what if the market is “down” and they don’t want to sell their positions? Also, selling investments that have substantial growth might make the taxpayer subject to other taxes such as capital gains, or income tax. The executor may also liquidate other assets. Real estate or other assets can be liquidated, however they may be sold at a financial loss, or the asset may have sentimental value to the heirs. The final way to fund the estate tax bill is from life insurance proceeds. This is the generally preferred way to pay for death taxes for several reasons: the heirs almost always get back more than was paid in; the proceeds may be free of estate taxation; it avoids many problems of liquidating current assets; the proceeds are usually not subject to probate; life insurance is not subject to income tax for beneficiaries; the payment benefit is prompt; life insurance provides cash for a predictable need which will arise at some unpredictable moment.
What are some examples of good and bad estate planning decisions?
When John D. Rockefeller, Senior died he had a gross estate of $26,905,182. He did not implement some basic estate planning tactics and his heirs wound up paying over $17,000,000 in estate taxes. This works out to roughly 64% of his entire estate.
It seems that Mr. Rockefeller’s son learned from his father’s mistakes. He planned properly and when John Jr. died he left behind an estate of $160,598,584. Because John Jr. had the proper estate planning team assembled, he owed a tax of only $24,965,954. This breaks down to only a 16% taxation rate.