Estate Taxes

How Estate Taxes Work

To be able to make the best decisions regarding investments and other ways to reduce estate taxes, you must first understand how they work. Learn how estate taxes work here.

To be able to properly prepare your estate plan, you need to be aware of how estate taxes work. When you die, your estate—everything you own and everything that is owed to you—will be tallied up at fair market value. Unfortunately, many people feel confident that their estate will is well under the exemption amount without the threat of paying estate taxes when it isn’t. Most people do not realize how estate taxes work, so they do not adequately calculate the value of their estate. With careful calculation many find that their estate values are well over the exemption amount, meaning that they will have estate taxes due.

It is important for you to realize what property will be included in your estate for federal estate tax purposes to be able to fully understand how estate taxes work. The estate includes all property owned by the decedent at the time of death, including investments, cash, real estate, vehicles, personal property, life insurance proceeds from policies owned by the decedent within three years of death, life insurance paid to the estate, retirement assets and business interests.

It is necessary for you to understand how estate taxes work when determining the value of your property. For tax purposes, your property will be “stepped up” to the fair market value at the time of your death. So, if you bought a house in 1960 for $50,000, and its fair-market value is $1 million the day you die, then you very well could be over the exemption limit for estate taxes.

The gross estate also includes assets passing through probate as well as assets inherited directly by joint owners or beneficiaries. This includes part interests, intangible property, property placed in a revocable living trust and other interests transferred by a decedent who retained control or an interest in the property.

Another thing you should know about how estate taxes work is that if you are married, everything that one spouse leaves to their surviving partner is estate tax-free. This is called the unlimited marital deduction provision. When both spouses have died, the heirs will owe estate tax if it exceeds the unified credit indicated for the year in which the surviving spouse dies.

With some planning, you can eliminate or minimize the piece your estate that your kids would have to pay to Uncle Sam. The first step is to know as much as you can about how estate taxes work, and then you should consult with an estate planning attorney or other professional.