But one consistent challenge in estate planning is the estate tax. Although only a small portion of people have to pay the estate tax, it is still essential to understand. But, what is it? Which estates have to pay it? And is there a way to reduce or avoid it?
This article provides a broad overview of estate taxes and links to more detailed articles that can help you answer specific questions.
Low-cost do-it-yourself (D.I.Y.) estate planning is possible in some simple cases and can be found on our companion site, FindLaw.com. Estate law varies from state to state, and estate planning situations can get complicated quickly. You may also want to consult with an estate planning attorney in your area for advice on your individual situation.
The estate tax, also called the "death tax," is a tax the federal government and some states levy on the value of a deceased individual's estate that exceeds an exemption amount. We determine the amount of the tax using the gross estate's value before distribution to the estate's heirs. The current federal statutory tax rate is 40%, but the estate tax exemption often lowers the effective estate tax rate.
Don't confuse the estate tax with real estate taxes, which are taxes levied based on the valuation of a property.
The federal estate tax exemption is the dollar amount, adjusted yearly for inflation, below which an estate is not liable for the estate tax. It does not matter if the estate's assets are distributed through a will, a trust, or the decedent died intestate (without a will), all estates are subject to the tax.
The exemption for 2021 is $11.7 million. It increased to $12.06 million in 2022. That means that in 2022, only estates valued at greater than $12.06 million must pay the estate tax.
Estate tax portability allows a surviving spouse to use the deceased spouse's unused exclusion amount (deceased spousal unused exclusion (DSEU)). Portability effectively enables a couple to combine their exclusions. So, in 2022, a married couple would have an exemption of $24.12 million.
Today, it is rare for an estate to pay a tax due to the high exemption amount. But, be aware that the current exemption amounts will expire on January 1, 2026, when the exemption amount will revert to $5,490,000 per person, indexed for inflation.
Because the federal government levies the estate tax on assets after the testator's death, one method of avoiding the estate tax is to reduce the size of the estate by gifting assets to heirs while still alive. The government implemented the gift tax to prevent this tax avoidance strategy.
There's an annual gift tax exclusion similar to the estate tax exclusion. This exclusion is applied annually to each person who receives a gift. The annual gift tax exclusion was $15,000 in 2021 and increased to $16,000 for 2022. So, in 2022, the testator can give up to $16,000 to each person they wish without paying the gift tax.
Before 2010, the federal estate and gift taxes received different treatment and had different exclusion amounts. The 2010 Tax Relief Act combined the exclusion amounts and applied a unified rate schedule to a person's annual cumulative taxable gifts and taxable estate. So, any gifts made by an individual while alive get applied toward the estate tax exclusion.
Many confuse the estate tax with the inheritance tax. They are similar, but where the government levies the estate tax on an estate before the beneficiaries receive any assets, the government imposes the inheritance tax on the beneficiary after receiving the estate's assets.
The US does not have an inheritance tax, but some states levy one. Whether a tax is imposed on an inheritance depends on where the beneficiary lives when they inherit the assets.
In addition to the federal estate tax, the following states also impose an estate tax, an inheritance tax, or both:
|State||Estate Tax||Estate Tax Exemption||Inheritance Tax|
|Connecticut||10.8% to 12%||$7.1 million||None|
|District of Columbia||11.2% to 16%||$4 million||None|
|Hawaii||10% to 20%||$5.5 million||None|
|Illinois||0.8% to 16%||$4 million||None|
|Maine||8% to 12%||$5.8 million||None|
|Maryland||0.8% to 16%||$5 million||Up to 10%|
|Massachusetts||0.8% to 16%||$1 million||None|
|Minnesota||13% to 16%||$3 million||None|
|Nebraska||None||None||Up to 18%|
|New Jersey||None||None||Up to 16%|
|New York||3.06% to 16%||$5.9 million||None|
|Oregon||10% to 16%||$1 million||None|
|Rhode Island||0.8% to 16%||$1.6 million||None|
|Washington||10% to 20%||$2.2 million||None|
Other states, such as California and Florida, do not levy an estate or inheritance tax. Because of the lower state exemption amounts, some estates that escape federal taxation must still pay the state estate tax. Many states assess their estate tax on a sliding scale based on the size of the estate over the exemption amount.
A life estate is an estate planning tool that ensures that a home is transferred to the next generation immediately after the homeowner's death while, from the time of death, avoiding the probate process. It's a form of joint ownership between a life-tenant and a remainderman.
In a life estate, a life-tenant maintains possession of the home during their life. The remainderman takes ownership of the house when the life-tenant dies.
The life estate's primary advantage is that it avoids probate, a process that may be time-consuming and expensive. It also allows the remainderman to take possession of the home almost immediately at the life tenant's death. Additionally, a life estate removes the house from the life tenant's estate, protecting it from lawsuits.
A life estate has disadvantages as well. For one, the life-tenant cannot sell or mortgage the property. Additionally, the life-tenant can be vulnerable to debt actions brought against the remainderman. Finally, it is not easy to undo a life estate if circumstances change.
The estate's executor uses Internal Revenue Service (IRS) Form 706 to calculate the estate tax owed on the decedent's estate under Chapter 11 of the Internal Revenue Code. The executor also uses this estate tax form to determine the generation-skipping transfer (GST) tax imposed by Chapter 13 of the code.
Additionally, the executor must file Form 706 when electing to transfer the deceased spousal unused exemption (DSUE) to the surviving spouse. In this case, the executor must file Form 706 irrespective of the size of the estate.
The executor must file Form 706 within nine months of the decedent's death with an automatic six-month extension granted by filing Form 4768.
The IRS Schedule K-1 is an annual form reporting gains, losses, interest, dividends, earnings, and other distributions from certain investments or business entities. Trust and estate beneficiaries will use a Schedule K-1 to report their share of an estate's or trust's income, deductions, or credits for estate planning purposes. Generally, Schedule K-1 income for trust and estate beneficiaries is considered unearned income.
Can I Deduct Estate Planning Expenses on My Taxes? No. Previously, some estate planning expenses incurred for the production or collection of income; the maintenance, conservation, or management of income-producing property, or tax advice or planning were deductible. But, in 2018, the Tax Cuts and Jobs Act removed those deductions. However, many of the law's provisions are due to sunset in 2025, so some deductions may return.
One should note that estate planning for the transfer of personal property, the most common form of estate planning, was not deductible before the Tax Cuts and Jobs Act. That means that estate plans consisting of common planning instruments such as wills, powers of attorney, living wills, and trusts designed to avoid probate are not tax-deductible
Is There a Way to Lower Estate Taxes? It's possible to minimize or eliminate estate taxes by lowering the estate's value below the exemption amount. One method is to use an intentionally defective grantor trust (IDGT). An IDGT is an irrevocable trust designed to remove assets from the grantor's estate.
Another strategy to reduce estate taxes is using an irrevocable life insurance trust (ILIT). When the insured is the owner of a life insurance policy, the policy's death benefit gets included in the insured's estate. However, the death benefit is not included in the insured's estate when the ILIT owns the policy. time of death valuation department of revenue
The federal government and Department of Revenue don't make it easy for the family of a deceased person to deal with federal estate tax returns, filing requirements, tax payments, and transfer tax. Income tax law legal matters can become complex and stressful for taxpayers and small businesses.
LawInfo intends to provide helpful and informative information in publishing this article and not to provide legal advice. A qualified estate planning lawyer can address your particular legal needs, explain the law, and represent you in court. Take the first step now and contact an attorney in your area from our directory to discuss your specific legal situation.