How estate tax works
Estate Tax Rates
The estate tax rate has fluctuated wildly since the federal estate tax was first enacted in 1916. In that first year, the top marginal tax rate -- the rate for each tax bracket for which the taxpayer qualifies -- was 10 percent of the value of an estate over $50,000. By 1917, the top rate more than doubled to 25 percent. By the 1930s, the rate had climbed to 70 percent and remained at 77 percent all the way from 1942 to 1976. Since 1976, the rate has been on a steady decline, settling at 35 percent in 2011 [source: Jacobson, et al ].
At first glance, even the relatively "low" 35 percent estate tax rate sounds pretty high. After all, the highest income tax rate is also 35 percent. What is important to note is that nobody really pays a full 35 percent of the value of their estate. The effective estate tax rate -- the actual amount that people pay in estate tax -- is around 14.4 percent under 2012 tax law [source: Brunet ].
the effective tax rate so much lower than the marginal estate tax rate of 35 percent? The first reason is because there are so many deductions and credits available to estates. As we mentioned earlier, estates can deduct any assets left to a spouse, all charitable contributions, funeral and estate administration expenses, outstanding debts, and more. If a large portion of your assets are from a small business or farm, you can take even more deductions. The estimated effective tax rate for farm and small business estates is only 7.4 percent [source: Brunet ].
Another reason the effective tax rate is so low is because the exclusion threshold is so high. Remember, under 2012 rules, only assets that exceed $5 million are taxed. So if your estate is worth $7 million, you're not taxed 35 percent of $7 million. You are taxed 35 percent of $2 million. And if you're married, the exclusion threshold is doubled to $10 million, exempting all but the wealthiest estates.
For lots more information on inheritance taxes, wills and estate planning, explore the links on the next page.Source: money.howstuffworks.com