Policy Basics: The Estate Tax
Updated December 14, 2012
A long-standing part of the tax system, the estate tax is a tax on property (cash, real estate, stock, or other assets) transferred from deceased persons to their heirs. It is levied not on the full estate but rather on the portion of the estate’s value that exceeds a specified amount of money, called the “exemption level,” minus deductions, such as for charitable giving.
In 2012, the exemption level is $5.1 million per person, $10 million per couple. The tax rate on amounts above the exemption level is 35 percent.
The estate tax serves as a “backstop” to the capital gains tax. Usually, capital gains are taxed when the asset is sold or disposed of and the gain is “realized.” But if a person holds an asset that grows in value until his or her death, that “unrealized’ capital gain is forgiven, and neither the heir of the estate nor the decedent is taxed on it. Without the estate tax, therefore, those unrealized gains would never be subject to taxation.
Tax’s Future Form Is Uncertain
Legislation enacted in 2001 gradually phased out the estate tax by raising the exemption level and reducing the rate. In 2010 the tax expired altogether.
The tax was slated to return in 2011 under the pre-2001 rules, with an individual exemption of $1 million and a top rate of 55 percent. But in December 2010, policymakers temporarily raised the exemption level to $5 million for individuals ($10 million for married couples), indexed it for inflation, and lowered the top rate to 35 percent.
That 2010 legislation expires at the end of 2012. In 2013 the tax is once again set to return to the pre-2001 rules — a $1 million per-person exemption and a 55 percent top rate — unless Congress acts.
President Obama has proposed reinstating the tax in its 2009 form, with a $3.5 million per-person exemption and a 45 percent rate. Members of Congress have made a variety of other proposals, with top rates ranging from 35 percent to 55 percent and exemption levels ranging from $1.4 million to $5.2 million per person. Some members have even called for a full repeal of the estate tax.
Effective Tax Rate Modest Under 2009 Rules
If Congress restores the estate tax at its 2009 levels, fewer than 3 of every 1,000 estates would owe any estate tax, and those that are large enough to owe the tax would owe 19 percent of their value in tax, on average. This “effective rate” would be much less than the top marginal rate of 45 percent for two reasons:
- As noted, the tax is applied only to the value of the estate that exceeds the exemption level. For example, at an exemption level of $3.5 million, an heir of an estate worth $4 million would owe taxes on at most $500,000.
- The tax contains a number of provisions to reduce heirs’ tax liability, many of them designed to protect farmers and small businesses. Most taxable estates have high proportions of liquid assets, so the vast majority of heirs owing estate tax can pay it without selling any property.
- Supporters argue that a significant estate tax is critical to supporting public services without imposing onerous burdens on middle-income Americans, particularly given our severe long-term budget problems.