The estate tax is a tax on ones net worth on the day they die. Because of the exemption amount, it generally only applies if your net worth exceeds $2 million for the years 2007 and 2008. So you can think of your estate as having the first $2 million to itself ($3.5 million for 2009). Then what is in excess of that being taxed at steep rates.
The question might be, If one gifted away all their assets, a day before they died, would the estate tax not apply? The answer is maybe. The gift tax and the estate tax are related, and one reason for that, is to limit the effectiveness of death bed gifts. Ones lifetime gifts, reduces ones exemption amount. So the $2 million amount above, is really $2 million less your lifetime gifts. And your lifetime gifts, are really what you give away, less the annual exemption amount that applies to gifts, when you made them. For 2007 the annual amount you can give away to one individual with out chipping away at your $2 million is $12,000. So one strategy if you seek to avoid the estate tax, is to start making gifts of $12,000 every year, to your family members.
Another factor to consider is that when virtually all of your assets transfer to your spouse upon your death, there are generally no estate tax issues, it does not apply. This assumes your spouse is a U. S. Citizen. But when your spouse dies, they are subject to the same rules, so if their estate is in excess of the $2 million, the government will tax it. So one way to reduce this tax, is to not leave everything to your spouse.
If ones net worth is $4 million and they are married, they could leave half to their spouse, and half to their children upon their death, and the half they leave to their children could go into what I call an A-B Trust, where the surviving spouse gets the income from the assets in the trust, and the beneficiaries get the principle of the trust upon the surviving spouses death. Half the estate is shielded by the unlimited martial deduction, and the remaining half is just at the exemption amount, and therefore not taxed. An A-B trust certainly requires legal advice, but it isn't that complicated. I'd guess on a $4 million net worth, it would save 2/3s of a million dollars. The savings is capped at the $2 million exemption amount times the 33% estate tax rate, so estates larger than $4 million would not save more than the 2/3s of a million dollars.
It is difficult to know what congress will do with the estate tax in the future? Apparently it all goes away in 2010 for one year. What happens after that is anybodies guess.
