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The federal estate tax is a tax on property (cash, real estate or stock, as well as other assets) that have been transferred from a deceased person to their heirs. Now, only certain individuals pay this type of federal tax because there is a limit of $5.49 million per person (the limit is double for married couples - $10.98 million). The estate tax limits large taxes for people who do not meet this threshold. In this case, the property transfer goes untaxed in most of the cases. This type of estate tax exemption is designed to protect low and middle-class Americans and has been a source of much debate during the past decades.
There are a lot of other details related to estate tax. Let's take a closer look at some of the most important facts:
Just 2 In 1,000 Estates Will Face Federal Estate Tax
Today, virtually all estates will go directly to the estate tax exemption program. This means that 99.8 percent of estates will not have to go into a tax-exempt trust in order to avoid taxes. In other words, only 0.2 percent of Americans who die will owe estate tax to the federal government. This is because the threshold for tax exemption has jumped from an initial $650,000, in 2001, to $5.49 million, in 2017. Thus, the new law protects the low and middle-class Americans and taxes the very rich and their heirs.
The Taxes Paid By Taxable Estates
Just a few estates must pay inheritance taxes, but how much do they pay? The effective tax rate for those that have to pay it is less than 17 percent, on average. This roughly translates to a sixth of the total estate. This number is far below the statutory number of 40 percent. There are a number of controversies related to the estate tax, but the proponents that support the idea that half of the estates go to taxes, are wrong.
But why is the effective rate of 17 percent and not closer to the statutory 40 percent? The answer is not as straightforward as you'd expect. For starters, the taxes are owed only for the amount that exceeds the threshold level. For instance, an estate worth $7 million will only have to pay taxes for $1,510,000 ($7 million – $5.49 million). This reduces dramatically the amount of tax money received by the government. Secondly, heirs can use various tools to deduct a large chunk of the taxes or can receive discounts based on various laws and regulations passed recently. Also, there are other loopholes (for instance, creating a tax-exempt trust) that help heirs avoid federal estate taxes.
The Large Loopholes – Tools To Avoid Taxes
The wealthiest individuals often hire entire teams of attorneys and accountants to create plans in order to exploit the numerous loopholes in the inheritance tax laws. This allows them to avoid massive taxes, even though their estates must pay a hefty amount of tax money. Unfortunately, these strategies don't benefit the economy, they are only helpful for those specific wealthy individuals.
For instance, some states use various tax-exempt trusts in order to avoid taxes. These can include grantor retained annuity trusts (GRATs). In this case, the estate owner puts money into the trust, plus an interest rate, over a period of two years. If the gain of the trust is larger than the interest rate determined by the Treasury, every additional gain becomes tax-free. If it doesn't go above the interest rate, the entire asset goes back to the initial estate. These GRATs trusts help wealthy individuals avoid immense taxes, especially when assets rapidly rise in value. Lawyers who work in this legal field estimate that billions of tax dollars go uncollected every year because of this loophole.
Who Owes Tax?
Besides the superwealthy, only a handful of small businesses and family-owned farms will owe any estate taxes. The exact number is 80. Yes, you've read it right... Only 80 small businesses and small farm estates will face any estate tax. The number comes after an analysis that takes into consideration small businesses with more than half of its value on a farm, with total business assets valued at less than $5 million. The taxes owed will be less than 6 percent of their total value, on average. The vast majority of these businesses have liquid assets (such as money in bank accounts) to pay the taxes without having to touch the actual business or farm.
Apparently, the estate tax exemption program is even more generous than was previously expected. Also, there is a special provision for these taxpayers. According to this provision, the taxpayer can spread the payments over a 15-year period at very low-interest rates, making the financial burden even more tolerable.
The Estate Tax Still Remains A Significant Source Of Revenue
Even though the estate tax seems very generous for most taxpayers, it still remains a significant revenue source for the federal government. The tax will generate less than 1 percent of the federal revenue over the next decade. This is less than what the government is already spending on the Food and Drug Administration, the Environmental Protection Agency and the Center for Disease Control and Prevention combined.
Most budget experts agree that the deficit must be reduced in order to address the long-term fiscal problems as the economy recovers from the last recession. The loss of tax revenue is problematic for the government and does not help the deficit reduction. Simply put, taxes are too low to help the economy and too many potential taxpayers use loopholes to avoid it. However, deficit reduction cannot be solved by applying more taxes to low and middle-class Americans. What's more, a possible repeal will leave even less money for investment, so the economy will suffer in the long run. Also, the United States has some of the lowest inheritance and estate tax when compared to similar countries.
If you are looking for more information on the following programs, please contact your estate planning attorney. Their expertise and guidance will extremely helpful in navigating this situation.
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