Estate Taxation

Under the tax law enacted in 2001, whatever you own is subject to the federal estate tax upon your death, until 2010. For the year 2010, estates will be entirely free from federal taxation. However, the law that includes this provision expires at the end of 2010. Thus, unless Congress acts in the interim, the estate tax rules will then revert to those prevailing in 2001.

For 2005, the tax rate on estates begins at 45 percent and rises to a maximum of 47 percent, depending on how much is being passed to your heirs. Between 2005 and 2009, the top tax rate will gradually be lowered to 45 percent .

That said, not all estates will be taxed while the estate tax is in effect. First, spouses can leave any amount of property to their spouses, if the spouses are U.S. citizens, free of federal estate tax. Second, the estate tax applies only to estates valued at more than $1.5 million in 2005 and this threshold will increase incrementally until it reaches $3.5 million in 2009 (see box). The federal government allows you this tax credit for gifts made during your life or for your estate upon your death. Third, gifts to charities are not taxed.

Most states also have an estate or inheritance tax. But more and more have moved to a so-called "sponge" tax, which ultimately doesn't cost your estate. The way this works is that the states take advantage of a provision in the federal estate tax permitting a deduction for taxes paid to the state up to certain limits. The states simply take the full amount of what you are allowed to deduct off the federal taxes. However, under the 2001 tax law the allowable state deduction is being phased out and will disappear in 2005. This means that many states are changing their estate tax laws to make up the difference. These changes may call for a restructuring of your estate plan; check with your attorney.