Key facts about estate taxes
The vast majority of Americans will never pay an estate tax. The federal exemption on estate taxes was $11.58 million in 2020 and $11.7 million in 2021.
Estate tax rates depend on the value of the estate over the exemption. They go up to $345,800 plus 40% of the value above the exemption.
12 states plus the District of Columbia have state estate taxes, which can start at estates of $1 million.
If you think your loved one’s estate may be liable for estate taxes, definitely consult a lawyer and/or a financial advisor.
When a loved one dies, they may leave behind some combination of possessions, land, real estate, cash, stocks, and other assets. They also might have mortgages and other debts, as well as assets they have designated to be left to a surviving spouse or to charity. Once you subtract these debts and bequests from the total of the assets, you are left with the fair market value of the taxable estate.
Depending on whether that value exceeds a certain amount, known as an exemption or an exclusion, the estate may be subject to the federal estate tax and, in some cases, state estate taxes as well. These exemption thresholds change as state and federal laws change, so make sure to consult a lawyer to assess your particular situation.
If the estate is large enough that it is subject to these taxes, it must pay them before it can honor the terms of the will by distributing any assets.
The federal estate tax exemption
In 2021, the federal exemption on estate taxes is $11.7 million. That is, if the fair market value of an estate is more than $11.7 million, anything in excess of that exemption is subject to taxation. So an estate worth $12 million only pays taxes on the $300,000 that is over the threshold. If the estate is worth less than that $11.7 million amount, the estate is completely exempt from this tax.
Keep in mind that these sums are per person. A married couple can leave twice this amount to their beneficiaries with no estate tax.
Of course, most estates are worth far less, so this particular tax is generally of little concern to the vast majority of Americans. In fact, of the estimated 3.1 million people who passed away in 2020, only 4,100 estates are expected to file estate tax returns, and even fewer, around 1,900, are expected to wind up paying any taxes on these returns.
Estate tax rates
The tax rate for estate taxes varies widely, and it depends on the value of the estate after the amount of the exclusion is taken out. This means that if an estate in 2020 was valued at $11.68 million, or $10,000 more than the exemption, it will be taxed at an 18% rate. If, on the other hand, it is valued at more than $12.7 million—a million dollars or more over the exemption—the estate tax will be $345,800 plus 40% of that amount over $1 million.
Most estates are worth far less than $11 million, so estate taxes are generally of little concern to the vast majority of Americans.
Tax rates can be complicated and, like the exemptions, may change or be subject to the particularities of individual estates. If you are dealing with a large estate, it is imperative that you consult with an estate lawyer or a financial advisor to help determine the potential tax bill and the factors that can change it.
State estate taxes
Depending on where your loved one lived, their estate may also be subject to estate taxes on the state level. Currently a dozen states plus the District of Columbia levy estate taxes. They are Connecticut, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Vermont, and Washington. Exemptions currently range from $1 million in Massachusetts and Oregon to $5.74 million in New York.
Some estates will pay estate taxes related to their state tax filing, but their fair market value will not warrant filing or paying any federal estate tax.
Though the prospect of paying estate tax twice—at both the state and federal levels—might be frustrating, there is some relief in that the estate tax bill from the state return is subtracted from the total value of an estate when calculating the amount owed at the federal level. It is always best to consult an estate lawyer or an accountant to fully understand the tax ramifications in individual cases.
Avoiding estate taxes
If your loved one was concerned that their estate would have to pay a big federal or state bill after they were gone, they may have taken advantage of an array of loopholes and workarounds to lessen that debt.
They may have decided to spend their money while they are alive, thus lowering the value of their estate. You can also make gifts of up to $15,000 yearly to loved ones without any tax on the gift, thus taking this money out of the value of the estate with no tax repercussions.
If they were married, they may have transferred assets of the estate to their spouse, though of course the spouse’s estate will then be accountable for any potential estate taxes when they pass away.
They may have left property in their will to a charity; the value of that property is deducted from the gross value of the estate.
Some people also choose to move their legal residence to a state which has no state estate tax, or to set up trusts to shelter their assets from taxes. Very wealthy people whose estates are valued at much higher sums than exemption levels often establish a Grantor Retained Annuity Trust, or GRAT.
If you need to know about any of these, consult a financial advisor or a lawyer.
Inheritance taxes are distinct from estate taxes; they exist only at the state level and only in six states: Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. (Maryland is unique in that it has both an estate tax and an inheritance tax.) Inheritance taxes also have thresholds in the millions of dollars, but they are levied on beneficiaries after an estate’s assets are disbursed, whereas estate taxes are levied on the estate before the inheritance is distributed. In most cases, inheritance taxes only apply to those who inherit from someone who is not their immediate family member.
Tax laws are complicated and frequently change, and even the smallest adjustments can have a big impact on a tax bill. To make sure your estate does not pay more than it needs to and that it doesn’t risk an audit down the line, take the time to ask for help understanding the laws where you live. You should consult an experienced financial advisor or an estate lawyer who can guide you through the nuances of different tax codes and explain to you exactly what the estate owes.
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