Estate Tax (Definition, Examples) | How to Calculate Estate Tax?

Estate Tax Definition

“Estate Tax” is a tax levied upon the inherited assets by heirs after the death of the asset holder and is calculated based on the market value of the asset(s) in question. However, a limit is applied over which the taxes are applied, plus, the amount which exceeds the limit is only eligible for such tax. In the U.S., IRS has applied a base limit of $11.4 million for the year 2019, over which an estate tax is applied once such asset(s) are transferred. This limit is not constant for each state within the country though, with a difference in the floor limit and rates for charging the tax.

Estate Tax is calculated as, Market Value of all property/estate owned at the time of death or to be acquired which is transferred to the heir over the state-imposed limit.
The estate includes all the assets of the deceased individual including cash and other interests.
Deductions from the calculation of the above estate: Any last minute rituals expenses and/or other monetary obligations on the deceased.

Examples of Estate Tax

Below are the examples of the estate tax.

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Example #1

Let’s consider, Joe left his family with $100,000 worth of assets upon his death. Will the family be liable for any estate taxes?

Solution

In this scenario – no. As the inherited assets are below the limit required for calculation of estate taxes, no estate taxes should be levied.

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Example #2

In the above example of the estate tax, consider that Joe has a family including his wife and 2 kids. After death, Joe left $15 million worth of assets for his family. Will his family be now liable for any estate taxes?

Solution:

Even in this case, the family is not liable. Joe’s wife would be considered as the legal heir to all his passed on wealth. Estate taxes are not levied if the spouse inherits the deceased’s wealth.

Example #3

Now consider that Joe’s wife passed away before him. After his death, Joe has now left $15 million for each of his kids. Now, we can determine estate taxes for Joe’s kids as each kid inherits assets worth more than the stipulated limit under jurisdiction.

Eligible amount for tax calculation will be:

$15,000,000 – $11,400,000: $3,600,000 for each kid

Or, $7,200,000 on the whole.

Once again, had Joe left a total of $15 million between both his kids, then they would not have been liable to pay any estate taxes.

Based on the table above, if Joe is a New York resident, below taxes applied would apply to his kids:

$238,800 to be paid by each kid.

Advantages

These taxes are not levied on the spouse. After death, if the estate of the deceased is passed on to the spouse, then no such estate taxes are levied. However, the same is not the case with other inheritors.
As the limit for assessing such taxes is high, the common man is not burdened with major obligations on basic inheritance. These tax services to be charged on the heavy pocket citizens of the State.
The tax serves as one of the major sources of revenue to the Government.

Disadvantages

It reduces the actually inherited value of an asset for the heir. After all, it is a form of tax to the taxpayer which is required upon inheritance. None the less, it can be viewed as receiving a less than expected value of the asset which has been passed on without having to earn by oneself.
There are means available to avoid or reduce such taxes, which can be planned by the asset holder before death. For e.g. instead of just passing on his estate, he may invest the equivalent money in avenues which pay returns later, or, he may distribute his wealth amongst more than 1 inheritors such that individually they do not breach the required limit for calculation.
It is calculated based on the market value of assets as on valuation date. Hence on that very particular date, if the market value is higher, estate taxes are higher than in general.

Limitations of Estate Tax

The major limitation set for such taxes is the high limit which is mutually decided amongst members of the financial department of any State. Hence, only very highly valued assets fall under the purview of its calculation. However, the limits set by the State are in consideration of all pros and cons.
Another major limitation to calculating such taxes is that it considers the market value of such assets as on valuation date. Hence, depending upon the situation, it may or may not differ on other dates and thus may or not may be eligible to estate taxes at all if it (or does not) breaches the required state threshold limit.

Important Points to Note about Change in Estate Tax

Limit for estate tax is dynamic every year, and changes with the law of the land. The Government of each state decides and determines the limit every year based on various parameters.
More the richness inherited, more the estate taxes levied on the inheritor. They are directly proportional to the wealth acquired.

Conclusion

Estate tax is very similar to inheritance taxes and gift taxes. The key difference between an estate and inheritance tax is that the latter is levied after the assets are passed on and depending upon the individual’s inheritance, they are required to pay their share of such tax. Gift taxes are levied during the lifetime of an individual when they pass on an asset of value greater than $15,000 or cash in such amount to other individuals. An individual is eligible for gift taxes every year when they pass on their assets/cash as gifts.