How IRS Code 2001 Governs the Federal Estate Tax

The federal estate tax is a tax on the transfer of property upon a person’s death. Governed by the Internal Revenue Code, this tax applies to the value of a decedent’s assets passed to heirs and beneficiaries. The rules dictating this tax outline which estates are subject to the tax, how it is calculated, and what credits can be applied. The framework ensures that significant transfers of wealth are subject to taxation, but it also provides substantial exemptions to protect most estates from any liability.

Determining if an Estate is Taxable

The initial step in addressing the federal estate tax is to determine whether an estate’s value is high enough to be subject to the tax. This process begins with calculating the “gross estate,” which encompasses the fair market value of all assets a person owns or has certain interests in at the time of their death. Assets included in the gross estate are varied and can include:

• Cash
• Real estate
• Stocks
• Bonds
• Business interests
• Other personal property

An estate is only required to pay federal estate tax if its value exceeds a specific threshold known as the basic exclusion amount. This amount is set by tax law and is adjusted annually for inflation. For 2025, the federal estate tax exemption is $13.99 million per individual. This higher exemption amount, set by the Tax Cuts and Jobs Act of 2017, is scheduled to expire at the end of 2025. Barring new legislation, the exemption is expected to revert to an inflation-adjusted amount of approximately $7 million in 2026.

If the total value of the gross estate is less than the exemption amount, no federal estate tax is owed, and in many cases, a federal estate tax return (Form 706) is not required to be filed. This threshold is a unified one, linked with the gift tax system, meaning taxable gifts made during a person’s lifetime can affect the amount of exemption available at death.

Calculating the Tentative Estate Tax

Once it is established that an estate’s value exceeds the exemption, the next phase is to calculate the tentative tax. This calculation does not start with the gross estate value directly but with the “taxable estate.” To arrive at the taxable estate, certain deductions are subtracted from the gross estate. These allowable deductions include:

• Funeral expenses
• Debts of the decedent
• Administrative expenses for settling the estate
• Amounts transferred to a surviving spouse or a qualified charity

After determining the taxable estate, the calculation incorporates “adjusted taxable gifts.” These are taxable gifts made by the decedent that were not already included in the gross estate. This step ensures that wealth transfers, whether made during life or at death, are treated in a unified manner for tax purposes.

With the tax base established, the tentative tax is computed by applying the relevant tax rates from the unified rate schedule. The tax rates are progressive, starting at 18 percent and rising to a top marginal rate of 40 percent for amounts over $1 million.

Applying Credits Against the Tax

After calculating the tentative tax, the next step involves applying available tax credits to reduce the final amount owed. The most significant of these is the unified credit, which is a dollar-for-dollar reduction in the estate tax. This credit is directly linked to the basic exclusion amount. The value of the credit is equal to the amount of tax that would be due on an estate with a value exactly matching the exclusion amount for that year.

Other credits may also be available in specific situations. For instance, a credit for foreign death taxes paid on assets located in another country can be claimed to avoid double taxation. There is also a credit for tax on prior transfers, which may apply if the decedent inherited property from someone else who died recently and whose estate paid federal estate tax. The executor of the estate is responsible for identifying and claiming all applicable credits on the estate tax return.

Understanding Portability of the Exemption

A feature of the federal estate tax system is the concept of portability. Portability allows a surviving spouse to use any unused portion of their deceased spouse’s basic exclusion amount. This unused portion is referred to as the Deceased Spousal Unused Exclusion, or DSUE.

Portability is not automatic and must be elected by the executor of the first spouse’s estate. This election is made by filing a complete and timely Form 706, the federal estate tax return, for the deceased spouse’s estate. This requirement holds even if the estate is not otherwise required to file a return because its value is below the exemption threshold.

The DSUE amount can then be used to shelter assets from gift tax during the surviving spouse’s lifetime or from estate tax at their death. For example, if the first spouse to die used only $3.99 million of their $13.99 million exemption, the surviving spouse could port the remaining $10 million. This would give the surviving spouse a total exemption of $23.99 million, assuming their own exemption amount is also $13.99 million.