Under the tax law enacted in 2001, whatever you own is subject to the federal estate tax upon your death, until 2010. For the year 2010, estates will be entirely free from federal taxation. However, the law that includes this provision expires at the end of 2010. Thus, unless Congress acts in the interim, the estate tax rules will then revert to those prevailing in 2001.
For 2002, the tax rate on estates begins at 41 percent and rises to a maximum of 50 percent, depending on how much is being passed to your heirs. Between 2002 and 2009, the top tax rate will gradually be lowered to 45 percent (see box below).
That said, not all estates will be taxed while the estate tax is in effect. First, spouses can leave any amount of property to their spouses, if the spouses are U.S. citizens, free of federal estate tax. Second, the estate tax applies only to estates valued at more than $675,000 in 2000 and 2001. This amount will rise to $1 million in 2002 and then increase incrementally until it reaches $3.5 million in 2009 (see box). The federal government allows you this tax credit for gifts made during your life or for your estate upon your death. Third, gifts to charities are not taxed.
Most states also have an estate or inheritance tax. But more and more have moved to a so-called "sponge" tax, which ultimately doesn't cost your estate. The way this works is that the states take advantage of a provision in the federal estate tax permitting a deduction for taxes paid to the state up to certain limits. The states simply take the full amount of what you are allowed to deduct off the federal taxes
Tax Year Tax Rate Exemption Equivalent
2001 37-55% 675,000
2002 41-50% 1,000,000
2003 41-49% 1,000,000
2004 45-48% 1,500,000
2005 45-47% 1,500,000
2006 46% 2,000,000
2007 45% 2,000,000
2008 45% 2,000,000
2009 45% 3,500,000
2010 N/A N/A