How the federal estate tax exemption has changed from 1997 to today.

How Exemption Works

Taxes are imposed on estates valued above the threshold set by the exemption rules established by the Internal Revenue Service (IRS). Only the value above the determined limit is subject to taxation. The exemption can be transferred to the surviving spouse as they are expected to inherit most of the estate and pass it on to the next generation upon death. Federal estate tax laws have changed several times in recent decades, resulting in a significant increase in the exempt threshold for 2022 and 2023.

How Exemption Works

Estates valued above the exempt limit are required to pay tax. Even in this case, tax is only imposed on the value exceeding the exemption limit.

The exemption for 2022 is $12.06 million, compared to $11.7 million in 2021. Therefore, the first $12.06 million of your estate is exempt from taxes. Your estate will not be subject to federal estate tax when filed in 2023 if it is valued at $12.059 million and you died in 2022.

The exemption is adjusted for inflation, so it tends to increase in most years, even when tax legislation does not affect it. In 2023, this limit will increase to $12.92 million. Most of the estate value exceeding the limit is taxed at a rate of 40%.

Note: The estate tax remains a very progressive tax as it is paid only by the wealthiest families.

Exemption is Portable

The government also allows your estate to transfer any unused portion of the exemption to your spouse if you are married. This provision is referred to as “portability.”

For example, you will have $6.06 million of “remaining” exemption in 2022 if your estate is valued at $6 million because the exempt limit is $12.06 million. You can effectively give this portion of the exemption to your spouse, increasing their exemption by that amount upon their death.

Your spouse is expected to inherit most, if not all, of your estate valued at $6 million, so they can pass that estate on to heirs without paying tax upon their death. The estate is also entitled to an exemption in the year your spouse passes away, and the unused exemption is added to that value.

Note: Your estate must file an estate tax return to inform the IRS that you are making this transfer, even though no taxes are due.

History of Federal Estate Tax Laws

The Taxpayer Relief Act of 1997 mandated a gradual increase in the estate exemption from $600,000 in 1997 to $1 million by 2006. This set the stage for larger increases in the coming years.

Estate taxes from 2010 to 2012 were based on the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act signed by President Obama on December 17, 2010, but the law was only in effect for two years. It was supposed to expire on December 31, 2012, so the federal estate tax exemption and rate were expected to revert to the previous applicable amount.

But that did not happen. Congress approved the American Taxpayer Relief Act (ATRA) on January 1, 2013, and President Obama signed it on January 2, 2013. The purpose of the ATRA was to make permanent changes to the laws governing federal estate tax, gift tax, and generation-skipping transfer tax.

We quickly moved to President Trump, who signed the Tax Cuts and Jobs Act (TCJA) in December 2017. The exemption was only $5.49 million in 2017. The TCJA more than doubled this amount to $11.18 million in 2018.

Exemption

Subject to Reduction After 2025

The TCJA is not permanent. It is scheduled to expire after 2025, and the exemption amount may revert to its pre-2018 level at that time unless Congress takes action to renew the legislation or some of its provisions.

Frequently Asked Questions

When is federal estate tax due?

The federal estate tax is due nine months after the person’s death. An extension of six months may be requested under certain circumstances.

How can I avoid federal estate tax?

Very few estates meet the criteria to pay estate tax. Many place their assets in trusts, gift money, and make charitable donations to reduce their federal estate tax bill.

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Sources:

– Tax Policy Center. “Number of Estate Tax Returns.”
– Tax Policy Center. “Briefing Book: Key Elements of the U.S. Tax System.”
– IRS. “Estate Tax.”
– IRS. “Instructions for Form 706.”
– Public Law. “PL 105-34 Taxpayer Relief Act of 1997,” Page 59.
– Congress.gov. “H.R.4853 — 111th Congress (2009-2010).”
– Congress.gov. “H.R.8 – American Taxpayer Relief Act of 2012.”
– Institute on Taxation and Economic Policy. “The Federal Estate Tax: An Important Progressive Revenue Source,” Page 4.
– Internal Revenue Service. “What’s New – Estate and Gift Tax.”
– Internal Revenue Service. ”Instructions for Form 706,” Page 1.
– IRS. “Filing Estate and Gift Tax Returns.”

Source: https://www.thebalancemoney.com/exemption-from-federal-estate-taxes-3505630