Among the basic tenets of estate taxation, these exemptions allow, as of the year 2008, every individual to transfer a total of $2 million during lifetime or at death, free of estate and gift taxes ($3.5 million in 2009).

Until recently, it was termed a "unified" exemption because gifts made during life also counted against the total (there was one overall exemption, and the individual used it up by making gifts during life and at death). Reform of the estate tax laws in 2001 has further divided this exemption into subcategories. The overall, or unified, exemption remains for the entire estate, but a gift exemption limits the amount that can be given during a lifetime.

Once the unified exemption is used up, the tax rates that apply are quite high. In effect, the rates start at 37 percent. While the exemption might, at first glance, seem generous enough so as not to even warrant any estate planning, it must be remembered that the goal of every small business owner is to build the business and amass wealth. While not every small business owner will be successful, many will find that they have accumulated a significant net worth, which will trigger the federal estate tax.

In addition, because of the 2001 reform act, the estate tax itself is being phased out over a 10-year period, but the gift tax will remain in place. The gift tax exemption is $1 million in 2008. In future years, the gift tax exemption will remain at $1 million, while the estate tax exemption rises until the estate tax is fully repealed in 2010. At that time, the top gift tax rate will equal the top income tax rate.

The following table depicts major changes to estate and gift taxes made by the estate tax reform of 2001.

Congress retained the gift tax out of concern that, with no gift tax, wealthy families would use gifting of assets to family members in lower income brackets as an income tax splitting strategy. Of course, this concern underscores the effectiveness of this strategy--which remains effective, subject to the $1 million lifetime gift tax exemption.

Furthermore, the annual gift tax exclusion is not affected by this legislation ($12,000 in 2008; $13,000 in 2009). This fact again bolsters gift giving as an effective strategy in reducing income and estate taxes.

Ultimately, many other factors can make a taxable estate larger than it may seem. During the 1990s, for example, the stock market made portfolios, and thus taxable estates, swell in value. In addition, without the use of other estate planning strategies, retirement benefits and life insurance can significantly add to the value of a taxable estate.

At these rates, much of the value of the business, built up through years of hard work, could end up being passed on to the federal government, rather than to the next generation, if estate planning strategies are not employed to avoid this outcome.