Estate Tax: Quick Overview of the Federal and Virginia Systems

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In its simplest terms, estate tax is a tax that is levied on the estate of a deceased person (also called a “decedent”) when the estate is transferred upon death. In recent years, there have been several changes in federal and Virginia state tax laws that govern how estate taxes are to be paid.

Federal Estate Tax Basics

The American Taxpayer Relief Act of 2012 established a maximum tax rate of 40% for the estate tax. This tax is applied to the gross estate of a decedent. The gross estate can be loosely described as the value of all property interests owned by the decedent at the time of death.

An important aspect of federal estate tax is a “unified credit” that is also often referred to as the “exclusion amount” or the “exemption amount.” The basic principle is that a particular amount of the estate – up to this exclusion amount – will be excluded from estate tax. The American Taxpayer Relief Act of 2012 set this exclusion amount at 5 million dollars. This amount is adjusted each year for inflation such that the specific exclusion amount in recent years has been as follows:

Year          Exclusion Amount

2011          $5,000,000

2012          $5,120,000

2013          $5,250,000

2014          $5,340,000

2015          $5,430,000

2016          $5,450,000

To see how this works as a practical matter, lets pretend that a decedent had an estate worth $15 million. If that decedent died in 2011, no tax is due on the first $5 million of the estate and taxes would only be levied on $10 million of the estate’s value. Likewise, if the decedent died in 2014, the first $5.34 million of the estate would be exempted from tax, with estate tax due on the remaining $9.66 million of the estate.

Using this same principle, a decedent with an estate valued at $2 million (or any value less than the exemption amount for that year) would owe no federal estate tax.

The increase in the exclusion amount in recent years has been significant. For example, in 2001, the exclusion amount was $675,000. As a result, creating an estate plan to address estate tax issues has become less of a concern for many.

Where Gift Tax Comes In

If estate tax applies only to transfers of property upon a person’s death, then conceivably transfers while one is still alive would avoid estate tax liability. Congress has anticipated this with the gift tax, which would apply to transfers of property during the donor’s lifetime.

It is important to note, however, that similar to the estate tax, gift tax has certain exclusions. Specifically, gift tax will not apply to the first $14,000 (this is the exclusion amount for 2016) given to any single recipient each year. Only amounts above the $14,000 exclusion amount will be taxed.

Exclusion from gift tax is also tied into the exclusion amount for estate tax. Remember how the exclusion amount for estate tax is referred to as the “unified credit?” The credit is “unified” because it applies to both estate and gift tax. Consider the following example.

Grandmother gives a gift of $35,000 to Grandson in 2016. The gift tax exclusion of $14,000 applies – so that potentially tax is only due on the $21,000 that is in excess of this exclusion.

However, the unified credit may also apply here. That $21,000 may be excluded from tax if Grandmother counts it as part of her $5.45 million unified credit. In other words, Grandma can shield the remaining $21,000 of the gift from tax by using the unified credit, and still shield $5,429,000 (or $5,450,000 – $21,000) of her estate from estate tax.

What about Virginia?

Yes, Virginia, the statewide estate tax has been repealed. In 2006, the Virginia General Assembly repealed the estate tax for all estates where the decedent died on or after July 1, 2007.