Estate taxes are often overlooked by many taxpayers, dismissed as an issue that only affects the ultra-wealthy. However, ignoring estate taxes can lead to costly surprises, particularly since rules can change frequently.
Both federal and state governments impose estate taxes, and understanding their nuances is essential for effective financial planning. With significant changes to federal exemptions scheduled for 2025, now is the time to gain clarity on this important topic.
In this article, we’ll provide answers to many of the most common questions about estate taxes that everyone should know.
Who Is Subject To Estate Taxes?
The estate tax is imposed on the estate of a deceased individual, which is treated as a separate legal entity by the IRS. While the estate itself is responsible for paying the tax, the burden ultimately falls on the surviving family.
The estate tax directly reduces the inheritance passed on to beneficiaries, which is why understanding and planning for these taxes is so crucial.
What You Need To Know About The Federal Estate Tax
Estate taxes are a complex and evolving area of the tax code, with significant implications for individuals and families. With scheduled changes to federal exemptions and varying rules across states, having a clear understanding of the basics is more important than ever.
While this article will provide a foundation, it’s only the beginning. Navigating the intricacies of estate taxes often requires professional guidance to ensure that your estate plan is optimized and compliant.
What’s Included In The Taxable Estate?
A taxable estate consists of all the property a person owns at the time of their death. This includes:
- Personal Property: Homes, cars, jewelry, collectibles, and other personal items.
- Investments: Stocks, bonds, mutual funds, real estate, and retirement accounts.
- Cash and Bank Accounts: Any liquid assets held by the deceased.
The total value of these assets is reduced by allowable deductions, such as debts, funeral expenses, and administrative costs, to arrive at the taxable estate.
How Are The Assets Valued?
Assets in an estate are typically valued at their fair market value (FMV) on the date of the owner’s death. This valuation determines the basis for calculating gains or losses on the estate’s property.
For instance, if an individual purchased a painting for $5,000 and its FMV at the time of their death is $20,000, the painting’s value for tax purposes is $20,000.
However, alternate valuation methods can be used under specific circumstances, adding complexity to the process.
How Is Estate Tax Calculated?
For federal purposes, the estate tax rate is 40% on the value of assets exceeding the federal exemption amount. In 2024, the exemption is set at $13.61 million.
Nonetheless, this exemption is set to decrease to $5 million (subject to inflation adjustments) following 2025. This looming reduction could significantly impact the tax liability of estates, making proactive planning essential.
Given the ongoing debate in Washington, D.C. about potential changes to exemption amounts, staying informed is vital.
Can Married Couples Double The Exemption?
Yes, with proper planning, married couples can effectively double their federal exemption. For 2024, this means a couple can shelter up to $27.22 million from estate taxes.
But with the anticipated reduction in the exemption amount after 2025, strategies to maximize this benefit should be reviewed and implemented promptly.
What Is An Inheritance Tax?
Inheritance tax, though often confused with estate tax, is a separate levy. Unlike the estate tax, which is paid by the estate itself, inheritance tax is paid by the beneficiaries who receive the assets.
Although the federal government does not impose an inheritance tax, six states—Iowa, Pennsylvania, New Jersey, Kentucky, Nebraska, and Maryland—have their own inheritance tax laws in place.
Fortunately, Iowa is in the process of phasing out this tax, with complete elimination scheduled for 2026.
What About State Estate Taxes?
Currently, twelve states and the District of Columbia impose state estate taxes, with exemption amounts that vary widely.
If you reside in one of these areas, understanding the rules and creating a tailored estate plan is crucial.
States with estate taxes include:
- Connecticut
- District of Columbia
- Hawaii
- Illinois
- Maine
- Maryland
- Massachusetts
- Minnesota
- New York
- Oregon
- Rhode Island
- Vermont
- Washington
How Are Gifts Handled?
Gifting is another area tied to estate taxes. For 2024, gifts exceeding $18,000 to a single individual in a given year must be reported to the federal government.
These gifts are subject to the gift tax rules, which are integrated into the broader estate tax system.
Strategic gifting can be an effective way to reduce the taxable estate, particularly when used to finance education, medical expenses, or other significant costs.
However, careful planning is necessary to avoid unexpected tax consequences.
Need Help With State Or Federal Estate Taxes?
At Minton CPA & Associates, we specialize in tax preparation and consulting services, including estate tax planning. Our team is here to help you navigate the complexities of estate taxes and develop a strategy that protects your assets and legacy.
Ready to take the next step? Call us today at 757-546-2870 to schedule a consultation and secure your financial future.