Are life insurance and jointly-held property considered part of the estate of the deceased, and thus subject to the estate tax?

When a person passes away and leaves behind an estate, the total amount of the estate’s value is subject to the federal estate tax. The percentage of the estate tax varies each year, and typically is applied directly to the estate’s total value, unless the value of the estate falls below a certain threshold, in which case the estate is exempt from the tax.

Determining the exact value of an estate can thus be critical. In order to ascertain the property and other assets that will be considered part of an estate – and thus potentially subject to taxation – an executor will need to understand the different forms of property ownership and the types of assets that are exempt from inclusion in the estate.

Determining the Assets and Property Included in the Estate for Tax Purposes

In general, life insurance proceeds must be counted when determining the value of the estate for tax purposes. As long as the decedent owned the life insurance policy, or the benefits are payable to the heirs of the estate, they will be added to the total value of the estate when determining the estate tax owed. Other types of property, including joint bank accounts and real estate, must also be factored into the total value of the estate for estate tax purposes.

Questions frequently arise when the deceased held property jointly with another person, such as a spouse, business partner, or some other individual. Survivors often wonder how to proceed in these situations, and whether or not they should expect federal or state estate taxes to be imposed on the jointly held property. The answer depends on whether the joint owner of the property in question is a spouse, and also on how the property is owned. Specific rules exist that govern property transfers from the estate of a deceased to the deceased’s spouse, and these rules create different outcomes depending on the manner in which the property was held. The following scenarios offer a look at how property law and estate tax rules play out depending on how the property is held.

Joint Tenants with Rights of Survivorship

If the property was held by both spouses as joint tenants with rights of survivorship (i.e. they each owned half of the property and each half automatically passes to the other) then the law considers each spouse to own 50% of the property’s value. Thus, 50% of the value will be considered part of the estate and potentially subject to estate tax. Because of the rights of survivorship, that half will automatically pass into possession of the surviving spouse, typically without any probate process. Furthermore, because spouses are entitled to a tax deduction on the value of estates passed to them from a marriage partner, the surviving spouse likely will not end up owing estate tax on the value of this jointly held property.

However, this may only delay the tax bill, rather than allowing the heirs to forego it entirely. Because the property need not go through probate when one spouse dies, estate tax requirements are not considered at that time. But when the final surviving spouse passes away, the property – valued in its entirety – will have to go through probate and will be considered taxable, which often presents an unexpected estate tax shock to heirs like the surviving children. 

Estate Tax When Spouses Own Property in a Tenancy by the Entirety

Tenancy by the entirety means that the two spouses don't have an independent interest in the property, and are considered to be one legal unit that owns the whole property. This means that there is nothing to pass upon the death of one spouse, as each owned the entire estate during life. The right of survivorship means one person succeeds to exclusive ownership. Therefore, no estate tax applies. It’s important to note, however, that this arrangement is currently available only to husbands and wives by marriage, and cannot be used by any other individuals to avoid estate tax requirements when property is transferred.

When Two or More Non-Married People Own Property Together with Rights of Survivorship

When the joint tenants with rights of survivorship are not married, the full value of the property in question will be included in the estate and taxed accordingly upon the passing of one of the owners. This does not apply if the surviving individual can prove they paid for the acquisition of their part of the property. In other words, if two business partners jointly own an office building, and one passes away, the surviving business partner must show proof of the payments he personally made for his share of the building. If he proves that he paid for 70% of the building, then the remaining 30% will be regarded as owned by the deceased and only that 30% will be subject to the estate tax.

As this overview suggests, property law and estate tax requirements can be complex. An experienced attorney can help you analyze the type of property ownership in question and determine the implications for the parties involved. Be sure to find an attorney who specializes in the types of assets that best represent your tax concerns, based on the nature of your ownership (for instance, marriage, business partnership, domestic partnership, corporation, or sole proprietorship).

A tax attorney can help you to minimize your tax liability when purchasing jointly held property. Your attorney can also help you determine what your tax obligations will be if the person with whom you hold joint property passes away. An estate planning attorney can also help you evaluate whether establishing a trust could help you shield your estate and assets from taxes.