Almost every large or small transfer of wealth is taxed in some way, and in the United States, taxes are also imposed on the transfer of inheritances conferred by a deceased person. This is known as the estate tax. The federal government allows for a certain amount of the taxable estate to be exempted from any taxation. This amount can change from year to year, based on the provisions of the tax code. For example, in the year 2006, the exemption amount was $2 million U.S. Dollars (USD), meaning that for an estate of $2.5 million USD in 2006, the taxable amount would be $500,000 USD, with the other $2 million USD is exempted from the tax.
Because of the fact that most estates are relatively simple and have a value of less than the estate tax exemption, the United States Internal Revenue Service (IRS) does not require the filing of an estate tax return for most estates. Even though the amount of the estate tax exemption changes from time to time, it is usually in the hundreds of thousands, or millions of dollars. This makes it so that the estate tax only affects a relatively small percentage of Americans.
Even so, there are a variety of services that have become available to people who think they will be eligible for the estate tax, to help them avoid the tax or reduce their tax liability as much as possible. Many insurance companies, financial planners, brokers, accountants, and other professionals offer estate planning services, and highlight these services to potential clients as a marketing technique.
The estate tax exemption applies to each individual regardless of marital status. In other words, if the estate tax exemption is $2 million USD in a given year, then it is $4 million USD for a married couple, instead of $2 million for an individual or a couple. This fact gives rise to one popular technique of minimizing estate taxes- that of creating a living trust. If done correctly, this will effectively double the estate tax exemption amount, greatly reducing tax liability. An irrevocable life insurance trust is another way to pass down tax-free inheritance to an heir, because again, if structured correctly, life insurance is free from estate taxes.
The use of one or more of these methods is necessary in order to be able to reduce one’s estate tax liability, because what otherwise would have been the most obvious solution -- simply giving away wealth to one’s intended heirs before death -- is not possible. The gift tax imposed by the federal government, which is assessed somewhat similarly to the estate tax, prevents that method of tax avoidance, although the gift tax also has exemption amounts that apply to the recipient.