Many taxpayers overlook federal estate taxes, assuming they won’t be affected. However, ignoring them could be a costly mistake. Why? Not only do several states impose estate taxes, but government officials often change the rules. In fact, a significant change is set to take place after 2025. That’s why understanding the basics of estate taxes is essential for all taxpayers. Below is a quick summary of key questions everyone should know the answers to:
Q: Who pays estate taxes?
A: The estate of a deceased person is considered a separate legal entity by the IRS, and the tax is levied on that estate. However, in reality, the surviving family bears the burden, as estate taxes reduce the inheritance.
Q: What is included in the taxable estate?
A: The taxable estate includes all personal property owned at the time of death—this could be homes, cars, cash, collectibles, and investments like securities, real estate, bank accounts, and retirement accounts. The total taxable estate is the value of these assets minus any deductible expenses and debts.
Q: How are assets valued?
A: For tax purposes, assets are typically valued at their fair market value (FMV) on the date of death. This FMV becomes the new “basis” for calculating any future gain or loss. For example, if John Smith bought a painting for $10,000 that’s worth $25,000 at his death, the estate will be taxed on the $25,000. There are some alternative valuation methods, but this area can get complex quickly.
Q: How is the estate tax calculated?
A: Federally, the estate tax is 40% on assets exceeding the federal exemption, which in 2024 is $13.61 million. However, the exemption is scheduled to drop to $5 million (adjusted for inflation) after 2025. Given the ongoing debate over this exemption, it’s important to stay informed about any future changes that could impact your estate.
Q: Can a married couple double the exemption?
A: Yes, if structured properly, a couple can shield up to $27.22 million ($13.61 million each) from federal estate taxes in 2024. Remember, this exemption amount is set to be significantly reduced after 2025.
Q: What is an inheritance tax?
A: Unlike an estate tax, an inheritance tax is paid by those who receive money or assets from the deceased’s estate. While there is no federal inheritance tax, six states (Iowa, Pennsylvania, New Jersey, Kentucky, Nebraska, and Maryland) may impose this tax. The silver lining? Iowa is phasing it out by 2026.
Q: Are there state-level estate taxes?
A: Yes, twelve states and the District of Columbia currently have estate taxes. The exemption amounts vary, with some as low as $1 million. If you reside in one of these states, it’s crucial to understand the rules and have a plan in place: Connecticut, D.C., Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Vermont, and Washington.
Q: How are gifts to others handled?
A: When gifting, the federal government doesn’t usually step in unless the value of gifts to a single person in one year exceeds a threshold. For 2024, that threshold is $18,000. While gift tax rules are intertwined with estate taxes, careful planning is essential—especially if you’re giving gifts to fund education or other significant expenses.
While this overview doesn’t cover every nuance of estate taxes, it should help you grasp the basics. You can find more information from the IRS here. The key takeaway? Estate taxes can be complicated, and knowing when to seek professional advice is crucial for protecting your legacy.
