Definition:
The federal estate tax is a tax on your right to transfer assets to your heirs and beneficiaries after your death. Taxable assets can include cash, stocks, bonds, real estate, and other valuable assets. The tax is only imposed on the portion of your estate that exceeds the federal exemption. In 2022, the federal exemption limit is $12.06 million. Estate tax rates range from 18% to 40%. In most cases, your estate is not subject to tax if inherited by a spouse. Estate tax is paid by the estate on assets exceeding a certain amount; inheritance tax is paid by the beneficiary on certain inherited assets.
How does the estate tax work?
The total tax due is calculated by summing the fair market values of all assets of the deceased at the date of death. Taxable assets may include cash, stocks, bonds, business interests, real estate, trusts, insurance, and other valuable assets. The total of all these assets is known as the “gross estate.” The value of your assets is not necessarily what you paid for them; it is their value at the time of your death. The executor or personal representative of the estate may also opt to value the assets at an alternate date six months later, provided they are not “distributed or sold or exchanged or otherwise disposed of during the six-month period,” according to the IRS.
Note: Using the alternate valuation date six months later can be beneficial if property is expected to decrease in value within that time frame, theoretically reducing the estate tax bill.
Credits and exemptions allowed in the estate tax are deducted from your gross estate. These credits can include property passed to charities, mortgages or other debts, and any costs and fees incurred to settle your estate. The tax is only applied to assets above a certain threshold. This threshold is known as the “estate tax exemption.” For 2022 (the tax return you file in 2023), the estate tax exemption is $12.06 million.
The tax rate depends on the extent to which your assets exceed the exemption limit. The rates range from 18% for assets valued just over $10,000 above the exemption to 40% for estates valued over the exemption by $1 million or more.
Who is subject to the estate tax?
The estates of all U.S. citizens and residents at the time of death are subject to the federal estate tax, but very few estates actually have to pay it due to the exemption. Only estates exceeding the exemption value after deducting exclusions and credits are subject to federal estate tax on the balance.
History of the estate tax
The estate tax exemption was initially set to rise with inflation under the provisions of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (TRUIRJCA). This law also set the highest estate tax rate at 35%.
These provisions were meant to remain in effect until December 31, 2012. At that time, federal estate tax laws were set to revert to the rules that were in place before 2001. This meant the federal estate tax exemption would drop to $1 million, and the tax rate would jump to 55% in 2013.
Then Congress and President Barack Obama acted in early 2013 to enact the American Taxpayer Relief Act (ATRA). This law made the changes implemented by TRUIRJCA permanent concerning estate tax, gift tax, and generation skipping transfer tax rules.
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In 2018, the Tax Cuts and Jobs Act (TCJA) more than doubled the exemption for 2017, which was already indexed for inflation.
Unlimited Spousal Exemption
One of the most significant exemptions for a deceased married person’s estate is the unlimited spousal exemption.
Remember that the estate tax is based on the value of the estate after deducting all available exemptions and credits. Generally, the spousal exemption allows the deceased to deduct all property in the gross estate transferred to the surviving spouse upon death.
Note: Generally, the IRS does not allow the spousal exemption if the surviving spouse is not a U.S. citizen.
Transferability of the Estate Tax Exemption
The Internal Revenue Code also provides for the transferability of the estate tax exemption between married couples. Transferability means that if you are married and predecease your spouse, you can pass on any unused exemption for them to use on their own estate.
For example, if your father left an estate worth $10 million upon his death in 2021, he still had $1.7 million remaining after applying the 2021 exemption of $11.7 million. If your father was married at the time of his death, he could pass that remaining $1.7 million of his estate to his wife. Now your father’s wife can shield an additional $1.7 million beyond any amount equivalent to the estate tax exemption at the time of her death.
A federal estate tax return must be filed if the executor of the estate wishes to grant the surviving spouse the spousal exemption, even if the deceased’s estate does not owe tax because its value does not exceed the exemption limit. Filing the form indicates that the transferability option is being exercised; to revoke the election, the executor of your estate must check the box in Part A of Form 706.
How to File an Estate Tax Return
The estate must file a federal estate tax return, Form 706, when the total gross value of the estate exceeds the exemption amount for the deceased’s year of death.
The Form 706 must be submitted to the IRS within nine months of the deceased’s date of death.
A request for an automatic extension can be filed using Form 4768. Any tax amounts owed on the estate that are not paid by the deadline will accrue.
Estate Tax vs. Inheritance Tax
Estate tax and inheritance tax are two different matters, but they are often confused. They are often grouped together under the unfortunate name of “death taxes.”
The estate tax is based on the total value of the deceased’s estate after deducting available exemptions, credits, and the estate tax exemption itself. It is paid by the estate.
The inheritance tax is based solely on the value of the inherited assets received by the beneficiary. It is imposed on the value of only those inherited assets. It will apply even if you inherit property, even if the estate is large enough to qualify for federal estate tax. If you are the beneficiary, you are responsible for paying any inheritance tax. Some individuals include provisions in their wills to allow the estate to assume this burden for their heirs.
The federal government does not impose an inheritance tax, but as of 2020, six states do: Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania.
Frequently Asked Questions
Is there an estate tax at the state level?
There are twelve states with an estate tax: Washington, Oregon, Hawaii, Minnesota, Illinois, Vermont, Maine, Connecticut, Massachusetts, Rhode Island, New York, and Maryland. The District of Columbia also imposes an estate tax.
How can I reduce estate taxes?
Source:
https://www.thebalancemoney.com/what-is-the-federal-estate-tax-3505647
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