Estate Tax – The Basics

Even after death, your heirs may still have to file a separate tax return for you with the Internal Revenue Service. If your accumulated wealth is greater than $11.6 Million, then your executor must file Form 706 – The Estate Tax Return.

This article will cover the basics of the estate tax. I’ll discuss the history of this tax and the current status. In addition, I’ll explain current requirements to file a tax return and how to document and comply with the code.  Finally, I’ll elaborate on why this tax is of importance to the small business owner. Future articles will explain techniques to minimize its impact on your financial health.

History of the Estate Tax

The modern day estate tax stems from the 16th Amendment to the Constitution. Prior to 1916, the estate tax took the form of a stamp tax. The estate had to pay for the right to record the transfer of property.  The US Government imposed the first form of the stamp tax in 1797 to raise money for the Navy. At that time, the US Navy was entangled in an undeclared war with the French Navy. Once the conflict quieted down, the stamp tax was repealed in 1802.

To assist in raising revenue for the Civil War, the Revenue Act of 1862 required an inheritance tax on the items transferred in one’s estate. The tax rate was .75 percent of the amount transferred and if the estate was bequeathed to a distant relative or a non-relative, the tax increased to 5%. This rate is low in comparison to modern day rates. Any estate less than $1,000 in value was exempt from the tax. Once the war debt was retired, the act was repealed in 1870.

The third use of the tax resulted from the Spanish-American War. A legacy tax was passed in 1898. Tax rates were as high as 15%. The minimum estate value for taxation was $10,000.  The act was repealed once the war was over.

Our current day estate tax is a result of the 1916 Revenue Act. It has evolved over the last 97 years whereby the minimum estate value for reporting and taxation is $11,600,000. To give you an idea of the number of deceased individuals qualifying for this tax, only 9,400 returns were filed in 2012. Over the last 20 years, the number of filed returns peaked at 73,100 in 2003. In 2008, the revenue raised was slightly more than $20 Billion. In 2012, the IRS collected $8.5 Billion in estate taxes from those 9,400 returns.

The Internal Revenue Service posts a wealth of information related to estate taxes.  A simple and straight forward example of information is this one page report: Estate Tax Statistics.

Current Filing Requirements

Very few individuals qualify to file a return or pay any tax. Congress has the minimum estate value to file a return at $5.25 Million for 2013 after an allowance for the following deductions:

  • Costs to administer the estate (probate fees, legal fees, court costs, agent fees)
  • Funeral costs (must be reasonable in nature)
  • Legal debts
  • Taxes related to death paid to the legal domicile (state) of the deceased
  • Charitable gifts at the time of death
  • Spousal bequests

All assets are considered in valuing the gross estate. From this gross estate are made the deductions as identified above to determine the taxable estate. If this taxable estate is greater than $5.25 Million than the executor of the estate must file Form 706 – Estate Tax Return. Any net estate is taxed in incremental levels up to 40%. In 2001, the maximum tax rate was 55%.

Returns must be filed within 9 months of the date of death. However, the executor may request a 6 month extension. Extensions are normal due to the nature of wrapping up estates and making sure the proper heirs receive their bequest.

Small Business Owner Effect

On average, over the last 10 years, the value of the small business impacted the value of the filed estates at about 8%. For most small business owners, your closely held operation does have a significant impact on your total wealth. It is important to have accurate information. The reason to properly value your business is a concept called ‘a step up in basis’ for your heirs.

Most small businesses are worth less than $2,000,000. If your executor reports to the Internal Revenue Service a value of $1,300,000, then your heir’s basis is only $1,300,000. Upon any future sale of the business or its assets, the heir will have to pay some type of capital gain tax on an additional $700,000. It is important to properly document your accounting affairs for tax purposes.

Summary – Estate Tax

The estate tax has a long and well established history in our government’s tool bag of revenue sources. However as the threshold for filing continues to rise, less and less taxable estates will be reported and therefore, the revenues sourced from estate taxes will continue to decline. The current minimum gross estate value must exceed $11.6 Million before filing Form 706. For the small business owner, it is important that an accurate value is place on your business in order for your heirs to receive the maximum basis in case of a future sale of the asset. Use the estate reporting requirements to assist you in minimizing your overall lifetime and legacy taxation. Act on Knowledge.

Value Investing

Do you want to learn how to get returns like this?

Then learn about Value Investing. Value investing in the simplest of terms means to buy low and sell high. Value investing is defined as a systematic process of buying high quality stock at an undervalued market price quantified by intrinsic value and justified via financial analysis; then selling the stock in a timely manner upon market price recovery.

There are four key principles used with value investing. Each is required. They are:

  1. Risk Reduction – Buy only high quality stocks;
  2. Intrinsic Value – The underlying assets and operations are of good quality and performance;
  3. Financial Analysis – Use core financial information, business ratios and key performance indicators to create a high level of confidence that recovery is just a matter of time;
  4. Patience – Allow time to work for the investor.

If you are interested in learning more, go to the Membership Program page under Value Investing section in the header above. 

Join the value investing club and learn about value investing and how you can easily acquire similar results with your investment fund. Upon joining, you’ll receive the book Value Investing with Business Ratios, a reference guide used with all the decision models you build. Each member goes through three distinct phases:

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  3. Sophistication – Most members reach this phase of understanding after about six months. Many members create their own pools of investments and share with others their knowledge. Members are introduced to more sophisticated types of investments and how to use them to reduce risk and improve, via leverage, overall returns for their value investment pools.

Each week, you receive an e-mail with a full update on the pools. Follow along as the Investment Fund grows. Start investing with confidence from what you learn. Create your own fund and over time, accumulate wealth. Joining entitles you to the following:

  • Lessons about value investing and the principles involved;
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Value Investment Club

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