Irrespective of the ups and downs we experience in life, only two things seem apparently inevitable: death and taxes. Want to know one thing that pulls these two together? It’s the federal estate tax. While the loss of our loved ones can have a gripping effect, along with dealing with the emotional trauma, estate taxes are also one thing you might have to deal with.
What Is The Federal Estate Tax?
The federal estate tax is the tax paid on the properties and assets transferred from a deceased person to their heirs. The tax is paid from the assets of the deceased estate before the remaining assets are distributed to the heirs. This means if you inherit money or property from your loved ones, you may be subject to federal estate taxes. But don’t panic because most estates do not qualify for federal estate taxes.
Are There State Estate Taxes, Too?
Apart from federal estate tax, assets may also be subject to state estate tax if you live in a state that imposes such tax. In addition, assets could be subject to state tax even if the value is below the federal estate tax threshold at the time of a person’s death.
Twelve states and the District of Columbia charge estate taxes. They include Washington, Oregon, Hawaii, Minnesota, Illinois, Vermont, Maine, Connecticut, Massachusetts, Rhode Island, Maryland, and New York.
How Much Is Federal Estate Tax?
The current federal estate tax rate set up through the Tax Cuts and Jobs Act (TCJA) in 2017 is typically between 18% for assets that are up to $10,000 more than the exemption and 40% for estates that are up to $1 million or more above the exemption, depending on how much the estate’s value exceeds the current exclusion limit which is currently $13.61 million.
For example, if you leave behind assets worth $14.61 million for your loved ones if you die, irrespective of where the assets are located, they make up your gross estate when calculating your federal estate tax. This means your estate has to pay taxes on the $1 million that exceeds the exclusion limit.
How Does Estate Tax Work?
The total tax due from the assets passed to you by your loved ones is calculated by summing up the fair market value of all the deceased assets as of their date of death.
However, the fair market value of the asset is not necessarily the amount paid when purchasing them but what the assets are worth at the time of a person’s death.
Apart from properties, other examples of assets subject to estate taxes include:
- Stocks and bonds
- A 401(k) and other retirement accounts
- Cash
- Personal property such as clothing, household furnishings or vehicles
- Business interests
- interest in life insurance or annuity contracts
- Other valuable assets
The total of these assets is what becomes your “Gross estate.”
Credits and allowable estate tax deductions, such as properties passed to charity, mortgages, debts, and any other cost incurred to settle the estate, are subtracted from the gross estate before paying the federal estate tax.
Rather than valuing the asset immediately, the IRS allows the administrator or executor of an estate to have everything valued six months later, provided that the assets aren’t sold, distributed, exchanged, or disposed of within the six-month period.
When Are Estate Taxes Due?
The federal estate tax return (Form 706) is usually due within nine months of a person’s passing, although the administrator or executor of an estate could request a six-month extension. If an estate tax is due, it should be paid on or before the original filing deadlines for the return unless the IRS grants a tax payment extension.
Who Is Subject To The Federal Estate Tax
All estates owned by U.S. citizens and U.S. residents are subject to federal estate tax at the time of death, but very few are required to pay. Only those who fall into the federal estate tax rate, as mentioned above, are subject to it.
Estate Tax And Marital Deduction
Even if an estate is subject to federal estate tax, one of the most significant deductions that can cut down the tax on married decedents is the unlimited marital deduction.
This allows a decedent to take a deduction for all properties in the gross estate transferred to the surviving spouse at death. However, the IRS does not allow marital deduction if the surviving spouse is not a citizen of the U.S.
Even better, the IRS provides an estate tax portability exemption for married couples.
Portability of estate tax allows a surviving spouse to inherit any unused portion of their deceased spouse’s estate tax exemption. In essence, if you are married and die before your spouse, you can pass unused exemptions to your partner to use for their estate, thereby doubling their exemption amount when it comes to their tax liability.
How To File An Estate Tax Return
You can file an estate tax return with your Form 706 if your estate exceeds the federal estate tax exemption. Although Form 706 must be filed within nine months of the decedent’s death, it can be extended automatically using Form 4768. Failing to pay any estate tax owed by the due date will lead to accrued interest.
Estate Tax Vs. Inheritance Tax
While estate and inheritance taxes are two different things, they often need clarification. On the one hand, the estate tax is typically based on the value of a decedent’s entire estate after the estate tax exemption, credits, and deductions are deducted and applied.
On the other hand, an inheritance tax is paid by the beneficiary, not the estate. It is charged at the state level and assessed by the state the decedent resides in at the time of their death. Only six states currently levy an inheritance tax, and Maryland is the only state in the U.S that charges both inheritance and estate tax.
How To Reduce Estate Taxes
Apart from the amazing benefits that marital deduction offers, there are other ways to minimize the financial impact of the federal estate tax. These include:
Charitable donation: if you decide to leave assets to a qualifying charity, the amount can be deducted from your gross estate before taxes.
Irrevocable trusts: an irrevocable trust essentially transfers the control of an asset from the grantor to the beneficiary, which protects it from creditors and reduces the value of the grantor’s total estate.
529 plans: 529 plans offer tax-free earnings and withdrawals for educational expenses. They are also excluded from your taxable estate.
Gifting: one of the easiest ways to cut down the size of your taxable estate is by distributing your assets while you’re still alive. You can gift up to $18,000 per individual in 2024 without paying federal gift tax or counting it towards your lifetime gift exemption.
Consult a tax expert: consulting tax strategy experts like Tax Goddess will help you implement estate tax strategies and break down the key aspects of estate taxes and planning to secure your legacy seamlessly.
Looking for expert estate tax planning strategies to secure your legacy? Book a free consultation call with the Tax Goddess Team today!
