Death, tax and "the death tax"

Ugh! Whenever I hear someone railing against the so-called 'death tax' I want to scream. First of all, there is no such thing. There are gift taxes and there is a tax on inherited wealth. Opponents (generally those who have been convinced by the wealthy that somehow these taxes hurt everyone) believe that the government wants to tax you when you die. Not true.

During your lifetime you make investments. When you sell those investments for a gain you pay a tax which is lower than your earned income tax. That's fair. When you die, whatever you have in your estate that totals no more than $5.45 million in almost every case is not taxed by the federal government. Your heirs not only get 100 cents on the dollar they get it without you paying for any gains.

Let's say you were a savvy investor and bought $1000 worth of Apple stock on July 9, 1982. Congratulations! You paid 21 cents for a stock that trades at about $100 today. Your modest outlay is now worth nearly $2.9 million. If you sell the stock you'll pay about $570,000 at the favorable 20% long-term capital gains tax rate. If you die tomorrow, your heirs will receive the full value of the stock and only pay taxes on gains after this date. Hence, you've "cheated" the tax man.

Now wait, then what happens if you had bought $2000 worth of Apple stock? You'd be sitting on $5.8 million and would trigger the 40% Federal Estate Tax. Yikes, would your estate now have to pay more than $2.3 million in taxes? Nope!

You see, the first $5.45 million is not taxed at all. The next $350,000 in this example would be subject to the estate tax up to 40% or $140,000. So with a $5.8 million windfall, a $140,000 tax bite translates into 2.4% tax hit. Not bad.

Tomorrow we'll talk about the gift tax and why now is a good time to be generous.