What Is Included in a Person's Estate for Federal Tax Purposes?
In a word, everything. The size of the probate estate has nothing to do with the size of the gross estate, which is the starting point for determining whether an estate is subject to federal estate tax. The gross estate is reduced by allowable deductions to calculate the taxable estate. Avoiding probate by keeping property out of your probate estate (with a living trust, or by other means) does NOT necessarily keep that property out of your taxable estate.
- Taxable estate is composed of ALL property interests that the deceased person owned.
- Life insurance proceeds, certain retirement plans, profit sharing plans, jointly held property, and property held in certain trusts is included in the taxable estate.
Changes made by the 2001 law
The 2001 tax law affected many states' gift and estate taxes. This influence will continue with the $5.34 million estate tax exemption for 2014 (up from $5.25 million for 2013). Historically, state death taxes have been much less significant than federal taxes because many states accepted the federal deduction for state estate tax as their tax amount. The 2001 Tax Relief Act changed this in a way that began costing the states significant revenue starting in 2002. Some states have responded by increasing their own inheritance and estate taxes to avoid loss of revenue resulting from these changes in the federal law.
What is in the gross taxable estate?
A decedent's gross taxable estate is composed of ALL property interests he or she owns. This includes:
- The decedent's share of his or her jointly owned property and accounts. If the other co-owner is a spouse, the law presumes that 50 percent of the property belongs to the decedent, and it is included in his or her gross taxable estate. But if the other co-owner is anyone other than the decedent's spouse, the law presumes that 100 percent of the property is owned by the decedent, unless the other co-owner can prove his or her actual contribution to that account or property. The IRS assumes in this situation that the decedent was merely shifting assets by setting up a joint account to avoid taxes, so the other joint owner is ignored.
- Qualified retirement plan accounts such as 401(k)s and profit sharing plans. Individual retirement accounts (IRAs) of all varieties are also included.
- Life insurance proceeds. If the decedent owns the policy at the time of death, the death benefit is part of the decedent's gross taxable estate, even though the beneficiary does not have to pay income tax on the proceeds. An estate that is seemingly below the taxable minimum of $5.34 million in 2014, can easily leap well past that point in size when insurance policy proceeds are counted. To avoid having life insurance death benefits included in the gross taxable estate is to transfer ownership of the policy to another person or trust.
- Property held in a trust the decedent controlled outright or in which he had significant "strings attached" is fully included in the decedent's gross taxable estate. A simple living trust, for example, will not save tax of any kind. A trust must be irrevocable and not under the full control of the grantor if it is to save estate taxes in the grantor's estate.
Everything you own at death is "on the table" when it comes to figuring your estate tax liability. That's why it's so important to make full use of all available tax-saving strategies and tools appropriate to your situation.