Example of How Estate Tax Is Calculated

The federal estate tax is a tax on the transfer of a person’s property to their heirs and beneficiaries upon death. It is not a tax on the property itself, but on the right to transfer that property. The decedent’s estate, managed by an executor, is responsible for calculating and paying this tax. This is distinct from an inheritance tax, which is levied on the recipients of the property.

Only a small fraction of estates are subject to the federal estate tax because the law provides a substantial exemption amount. If the total value of an individual’s assets falls below this high threshold, no federal estate tax is owed.

Determining the Gross Estate

The initial step in the estate tax calculation is to determine the decedent’s gross estate. This involves identifying and appraising all property and assets owned or controlled by the individual at the time of death. The valuation standard is the “fair market value” on the date of death, which is the price at which the property would change hands between a willing buyer and a willing seller.

A wide array of assets must be included in the gross estate calculation. This includes tangible assets like cash and real estate, as well as financial assets. Other assets that must be tallied include:

• Stocks, bonds, mutual funds, and other investments
• Valuable personal property such as art, antiques, and jewelry
• Proceeds from life insurance policies owned by the decedent
• The total value of retirement accounts, such as 401(k)s and IRAs
• Business interests, like a sole proprietorship or partnership shares, which must be professionally appraised

Calculating the Taxable Estate

Once the gross estate is fully valued, the next phase is to calculate the taxable estate. This is accomplished by subtracting specific, legally permitted deductions from the gross estate total. These deductions reduce the value of the estate that is exposed to potential taxation.

A significant deduction is the unlimited marital deduction. This allows for the tax-free transfer of any amount of assets from the deceased spouse to the surviving spouse. For this to apply, the recipient spouse must be a U.S. citizen and the assets must pass directly to them.

Another deduction is for charitable contributions to a qualified organization designated in the will or trust. Additional deductions can include:

• The decedent’s debts at the time of death, such as mortgages and credit card balances
• Funeral expenses
• The administrative costs of settling the estate, including legal and accounting fees

A Comprehensive Calculation Example

To illustrate, consider the case of John Doe, who passed away in 2025. John’s assets consist of a primary residence valued at $2,000,000, a stock portfolio worth $12,000,000, a 401(k) valued at $1,500,000, and a life insurance policy he owned with a death benefit of $1,000,000. John was not married at the time of his death. His will leaves a bequest of $500,000 to a qualified university, and at his death, he had an outstanding mortgage of $400,000 and funeral costs of $25,000.

First, we calculate John’s gross estate by summing his assets: the $2,000,000 home, $12,000,000 stock portfolio, $1,500,000 401(k), and $1,000,000 life insurance policy. The total value adds up to a gross estate of $16,500,000.

Next, we determine the total allowable deductions. The estate can deduct the $400,000 mortgage, $25,000 in funeral expenses, and the $500,000 charitable bequest. Subtracting these total deductions of $925,000 from the gross estate yields a taxable estate of $15,575,000.

The final step is applying the 2025 federal estate tax exemption of $13,990,000. The amount of John’s estate subject to tax is found by subtracting the exemption from the taxable estate ($15,575,000 – $13,990,000), which equals $1,585,000. The estate’s tax liability is then calculated by applying tax rates of up to 40% to this amount. This high exemption is scheduled to expire at the end of 2025 and, without new legislation, will revert to a lower level in 2026.

Filing the Estate Tax Return

The executor must report this information to the government using IRS Form 706, the U.S. Estate Tax Return. This form requires a detailed listing of all assets, deductions, and the final tax calculation. The most current version of Form 706 should be obtained from the IRS website.

The deadline for filing Form 706 is nine months after the date of death. An automatic six-month filing extension can be requested by filing Form 4768 before the original deadline. However, an extension to file is not an extension to pay; any estimated tax must be paid by the original nine-month deadline to avoid interest and penalties.

The completed Form 706, along with supporting documents like appraisals and the will, must be mailed to the IRS service center specified in the form’s instructions. After the return is filed, the IRS will review it. The estate may eventually receive a closing letter from the IRS, which formally accepts the return and concludes the estate’s federal tax obligations.