Estate Taxes 101: What You Need to Know to Protect Your Legacy

Estate Planning

Estate planning is a critical component of financial wellness, but it doesn't stop at deciding who will inherit your assets. Protecting your legacy also involves understanding the tax implications, notably estate taxes, which can significantly erode the value of the estate you leave behind. Here’s what you need to know about estate taxes to ensure that your legacy remains as intact as possible.

Estate Taxes

Estate tax is a tax on the net value of your property upon your death before distribution to the heirs. It consists of an accounting of all of your assets. There is a federal estate tax in the United States, and some states have their own separate estate taxes. When a person dies, their assets could be subject to estate taxes and inheritance taxes, depending on where they lived and how much they were worth. These taxes are assessed based on the total value of an individual's estate, which can include real estate, investments, cash, and other assets. Estate taxes can be complex and are subject to varying rules and exemptions at both the federal and state levels in the United States.

Federal Estate Taxes

Federal estate taxes are taxes levied by the United States federal government on the transfer of a deceased person's estate before the assets are distributed to beneficiaries. The tax is based on the total value of the estate, which can include everything from real estate and investment accounts to personal property like artwork and jewelry. Importantly, federal estate taxes are separate from any state estate or inheritance taxes that may apply, and they are also separate from income taxes that the deceased or their estate may owe.

Exemption Amount: The federal estate tax exemption amount is $12.92 million per individual in 2023. This means that an estate valued below this amount would not be subject to federal estate taxes. Married couples can effectively double this exemption to $25.84 million.

Tax Rates: For estates that exceed the exemption amount, the tax rate is progressive, reaching up to 40% for the portion of the estate that exceeds the exemption. It's important to note that only the value of the estate that exceeds the exemption is subject to the tax, not the total value of the estate.

Portability: Federal estate tax law allows for "portability" of the estate tax exemption between spouses. This means that if one spouse dies and does not use up their entire exemption, the surviving spouse can add the unused portion to their own exemption. However, this is not automatic; an estate tax return must be filed for the first spouse who dies to claim the unused exemption, even if no tax is due.

Who Is Responsible for Paying?

The estate tax is typically the responsibility of the estate itself, not the beneficiaries. The executor of the estate is usually the one who files the federal estate tax return and pays the tax from the assets of the estate.

Due to the high exemption amounts, most Americans are not affected by federal estate taxes. However, for those with significant assets, various strategies like trusts, charitable donations, and gifting can be employed to minimize estate tax liability.

Given the complexity of federal estate taxes, and the potential for laws to change, it's advisable to consult with tax professionals and estate planning attorneys to navigate the complexities and ensure that assets are passed on to heirs in the most tax-efficient manner.

State Estate Taxes

Some U.S. states have their own estate taxes, and these can have significantly lower exemption amounts and different tax rates compared to federal estate tax. State estate tax laws vary widely, so it's essential to understand the rules in the specific state where you reside or own property. The number of states with their own estate tax has fluctuated over the years, but those that do have one often have lower exemption thresholds and different rate structures compared to the federal estate tax.

Exemption Amounts: Exemption amounts for state estate taxes are generally lower than the federal estate tax exemption. In some states, the exemption can be as low as $1 million or even less, making it far more likely that an average estate would be subject to state estate tax.

Tax Rates: The rates for state estate taxes can vary and are generally progressive, just like the federal estate tax. However, the top rates are often lower than the federal maximum rate of 40%.

No Portability: Most states do not offer "portability" of estate tax exemptions between spouses, unlike the federal estate tax system. This means that if one spouse dies and does not use their full state estate tax exemption, the unused portion cannot be transferred to the surviving spouse.

Estate taxes play a large role in estate planning, particularly for individuals and families with significant assets. Understanding how estate taxes work is essential for formulating a plan that ensures the efficient transfer of wealth to the next generation or other beneficiaries. The state you reside in could have a substantial affect on your estate tax liability.

If you have any questions, call or text 833-MIKE-247 to speak directly with an estate planning attorney.