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Estate tax introduction

Overview of the estate tax. Created by Sal Khan.

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  • mr pants teal style avatar for user Evy
    Is the $5 million exemption per deceased? Or per recipient? Say instead of having just one daughter, a person with a $10 million dollar estate has ten children among whom he is dividing the money equally in his will. Will each of his ten children get $1 million untaxed? Or will each of them receive $500,000 untaxed plus whatever the other half portion is left after taxation? And how is the estate tax applied if the deceased wants to spread the inheritance among his siblings and other friends and family? Is there a separate rule about leaving money for the surviving spouse, or even a parent of the deceased? What about the payouts from life insurance? Does that factor into part of the estate? Or is that automatically exempt? (For example, we don't claim car insurance payouts as "income".)
    Also, how would the joint $10 million exemption be applied? For a couple to pass away at the same time, or even in the same year would be a rare, and unfortunate, occurance. Is that the only scenario where the $10 million exemption comes into play?
    (46 votes)
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  • orange juice squid orange style avatar for user Rodrigo Alves
    At you say that a family's wealth will grow faster than the country's economy. Why is that? What's makes it grow this faster?
    (19 votes)
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  • blobby green style avatar for user Shazil Hayat
    Couldn't you transfer all of your wealth to your child before you die and not pay an estate tax?
    (17 votes)
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    • leaf green style avatar for user David Cross
      Not really, gifting during life for estate tax purposes is only good for the very wealthy. Gifts given during life are subject to gift tax which mirrors the estate tax scheme. You get a yearly exemption from the gift tax for up to $14,000 (this figure adjusts for inflation), and you can give the exemption amount to as many people as you like. This all sounds good till you realize that gifts given at death get a full step-up in basis where as gifts given during life do not. So in reality it is a balancing act, you must compare estate tax savings to capital gain/income tax savings. By the way, most people are not subject to estate tax or gift tax, every individual get a $5.43 million exemption (one exemption for both taxes). So you must have an estate with a value higher then $5.43 million to be subjected to the estate or gift tax.
      (6 votes)
  • blobby green style avatar for user Leandra Nkiruka Harewood
    I was a little unclear, please assist. Is Sal saying that if both parents died at the same time then the child/children would be entitled to an exemption of 10m? If they didnt die at the same time then the child is only entitled to 5m or is it about how the ownership of the funds/property is set up (in either one parent's name or both parent's name- regardless if only one dies) that determines if their offspring/the persons they left money for are entitled to 5 or 10m exemption?
    (11 votes)
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    • blobby green style avatar for user Daniel Smith
      Now this rule has changed, as of 2011 the surviving spouse may take the unused credit of the first spouse. Ex. I die and leave everything to my wife (no tax due to unlimited marital deduction) my wife has her $5MM plus my $5MM exemption so she can leave $10MM estate tax free. Referred to in the business as "portability", meaning the unused exemption of the first spouse is portable over to the surviving spouse.
      (12 votes)
  • female robot amelia style avatar for user Jade
    Say an older guy marries a younger woman (happens all the time) and dies (also happens all the time), leaving her to inherit his $5M and her own $5M. She RE-MARRIES. This guy also has his own $5M. If one of them were to die, how much would the surviving spouse inherit? As I understood it, spouses are exempt from this tax. So they'd inherit all of it, right?
    (8 votes)
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  • blobby green style avatar for user pasindumuth
    why not just deposite the money you earn into a bank account and let it sit there to grow and avoid taxes rather than dumping it into and estate tax where you end up losing money??
    (3 votes)
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  • blobby green style avatar for user sbbhanari
    hey sal i need little bit more help .i understood that minimum taxable amount is 5m,if
    some guy worth of 7 million and decided to give 3.5 million to his daughter and remaining money to his son ,how the tax is done in this case .
    (5 votes)
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    • blobby green style avatar for user Karen
      It is not the person that receives but the person who gives that is taxed. In estate tax, it is usually the deceased person's representative filing and paying the estate tax before the remaining money is distributed to beneficiaries. The first 5 million is exempt from estate tax. The other 2 million is taxed at 35%. (It is not really as straight forward as this but to keep it simple...) But if a COUPLE were worth 7 million, then they have a combined exemption of 10 million so it is under this condition it would all be exempted.
      (2 votes)
  • leafers ultimate style avatar for user Andris
    Why can we be so sure that the 10 billion dollars will grow faster than the GDP? Real interest rates are not necessarily higher than GDP growth, are they?
    (3 votes)
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    • male robot hal style avatar for user Andrew M
      Not all the time, but over long periods of time, real rates should at least match real GDP growth, because after all, how do you get GDP growth? By investing. If you look at the country as just one giant business entity, it should have a growth rate equal to its cost of capital times its reinvestment rate.
      (6 votes)
  • male robot hal style avatar for user Tod Knutson
    After the estate tax is paid and the remaining assets are transferred to the inheritor, does that person have to pay income taxes on the assets they collected?
    (3 votes)
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  • blobby green style avatar for user timothyihaynes
    Why can't you sell all your stuff to your children before you die?
    (2 votes)
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Video transcript

What I want to do in this video is think a little bit about the estate tax. As the name of the tax implies, it is a tax on someone's estate or when someone passes away, it is a tax on what they want to leave behind to whoever they want to leave it to either in their will or in their family or whoever they want to leave their stuff to. Sometimes it's referred to as an inheritance tax and sometimes you'll hear it talk this ways on the news, maybe it's a little bit derisive. It's called a death tax. The general idea, let's say that right now my entire net worth, I am worth $3 million and then I pass away. This $3 million goes into my estate. This is my estate. So this $3 million could be all of my savings, could be my stock portfolio, it could be the value of my land, my real estate. Everything I own. My car. Everything combined is worth $3 million. It goes into my estate after I pass. Let's say I leave everything in my estate to my daughter. I leave it to my daughter. It's at this point that the estate tax comes into question of how much money will my daughter get. It turns out for $3 million my daughter is exempt for inheritance from an individual. The first $5 million are exempt. In this situation where I'm leaving $3 million for my daughter she actually will get the entire $3 million. If, let's say I'm even richer than that. Let's say that I have $6 million. Let's say the scenario where I have $6 million it all goes to my estate after my death and now the first $5 million is exempt. Let me write my daughter over here. My daughter will get the first 5 million tax free and then the increment above that exemption, the increment above what has been excluded will then be taxed at a certain rate and that rate is constantly changing. For the sake of simplicity I'm going to go with the 35% and that's actually the rate in 2011. The rest of the 1 million, the 1 million taxed at 35%. The federal government will tax 35% of the 1 million. They will essentially take 350,000 for themselves and my daughter will be left with 5,650,000, right? Because of this million you'd take out 350,000, you have 650,000 left. My daughter in this situation will be left with $5.65 million. The federal government took 350,000. If I am super rich, let's say that I am worth, let me make a number to make the math easy so that I don't have to get a calculator out. Let's say that I am worth $1,005,000,000. This is my net worth. In this situation, the first 5 million will be excluded. My daughter will get the 5 million directly, that will be excluded. Then everything above that will be taxed at the 35%. In this situation you have $1 billion taxed at 35%. 1 billion at 35%. In this scenario the federal government will take $350 million and so that would leave of this billion 650 million left my daughter. In total, she would get this 650 million plus the 5 million that was excluded. She would end up with a total of $655 million. I wouldn't feel too bad for her, she should be pretty okay. That's just how the estate tax works and these examples I gave with the 5 million that is excluded, this is for an individual when they pass away. If it's being done as a couple, this exemption is actually 10 million. Between my wife and I, we have $1,005,000,000. Let's say I pass away and we own everything collectively. She actually gets the extra joint exemption passed on to her. Then if and when she passes away, this would be $10 million that will be tax free. In this scenario, if this is being done as a couple my daughter would get the entire $6 million. The interesting thing about the estate tax is it's highly contested. People always debate, is it wrong or is it right? I'll talk to you on that a little bit. I'll let you decide for yourself. But I'll give, at least, in what I hear is the main arguments for or against the estate tax. Like most taxes, there's always someone who will believe that it is unfair. Let me write the for and against. For and against the estate tax. Some people say it's unfair, "Look. Over the course of my life "I earned all of these money. "I paid all of these income taxes "off of the money I earned "and now the stuff that I want to leave behind to my children "I am not able to leave it all to them. "Because obviously $655 million is not enough. "They deserve the entire $1,005,000,000 for being my child." So there's this argument that it is unfair or it's some double taxation. The money was taxed the first time it was earned and now it's being taxed again once it's being inherited. The counter argument to that is double taxation is everywhere in our society. Corporations pay taxes and then they give dividends and the stock holders pay taxes again and that's an exchange for having the limited liability of the corporation. You pay taxes on your income and then with that after tax income you go buy something at the store, once again, you pay sales tax. Double taxation, it happens everywhere. The for argument and somewhat the counter argument against the unfairness of it all is that, "Look. We're exempting," depending on how you view it, "the first $5 million or $10 million." $5 million to $10 million is exempt. The person who's for the estate tax would say look, it's a little disingenuous when you make this impression that your children are going to suffer. They're not going to be able to get your house or they're not going to be able to get your car. They're going to be able to get all of that as long as it's worth less than $10 million which is not a small amount of money. Even above that, they're going to get 65% of everything. It's not like your children are going to be left hungry because of the estate tax. It's actually a very small number of people that the estate tax will even hit, really, the rich because even the upper-middle class, very few of them will leave more than $10 million behind. The other argument is, if you're going to tax anything. What to tax? Do you tax income? Obviously, you do have to tax income to some degree to get enough revenue for the federal government. Isn't it better to tax someone who did not work for the money? Someone who's getting the money, I mean, maybe they already got every other privilege in life. They went to the best schools and all the rest and through connections, maybe, good jobs. Why not tax the person who is already lucky to some degree by virtue of, and this is just the argument someone would make. By the way, they're sill going to get a lot of that money. It's not like they're going to be left poor. They're still going to be fine. To some degree, maybe if they have a little bit less it will be more of an incentive for them to work. The other argument for the estate tax, and this is a broader, almost a macro view of things of what might be good for society is if you don't have an estate tax and we know that there's this huge fortunes in the world where someone creates a big business empire and they have billions upon billions of dollars. If someone has $10 billion, and let's say they don't have that many children that they leave it behind to. Maybe they only have one child and they leave that $10 billion to that one child. Then that one child can literally just let that income passively earn interest. They'll never have to work the rest of their life and through the passive earnings of just the assets being invested, over the course of that child's life might grow to $30 billion. It will definitely grow faster than the economy itself. Then that child, if they have no estate tax, they'll pass the $30 billion to their children and then that will grow. What you would have happening generation after generation is this family, if you say the person who sets up the empire. Let's say this is the entire country's GDP. Right where the empire sets up in this person's lifespan, this is their proportion of the GDP and this is just for simplicity. If you don't tax it and just passively over the course of the next lifespan, if there aren't enough offspring to split up this fortune, as the GDP grows these people's investments will grow even faster passively. Overtime, this family will grow to own more and more of the nation's wealth without really having to do anything. It almost creates this nobility class and obviously that's what, at least many people in the United States view as what's different about America relative to old Europe, to what used to happen in terms of the French revolution, and people just inheriting land generation after generation and never having to work. This right here is a quote from Winston Churchill on his view of an inheritance tax. He viewed it as a certain corrective against the development of a race of the idle rich. Anyway, that's the explanation of it. You can stand for either side of it but hopefully this at least gives you the tools to think about whether you're for or against it.