Estate Taxes Overview
Many people mistakenly assume that if you avoid probate by setting up a living trust rather than having a will, you will also avoid paying estate taxes to the government. Avoiding probate does not avoid taxes.This article provides some basic information on federal and state estate taxes and who must pay them.
Federal Estate TaxIf you have a large estate, estate tax may apply at your death. Your taxable estate is your gross estate less allowable deductions (see below). A federal estate tax return must generally be filed for the estate of every U.S. citizen or resident whose net estate, the estate after applicable deductions, exceeds specified thresholds. Those limits are indexed for inflation, beginning after 2011. The table below shows the threshold amounts:
|Decedent dying in||Exclusion amount|
Estates subject to estate tax are generally fairly large. Most simple estates (cash, publicly traded securities, small amounts of other, easily valued assets and no special deductions) with the total net values shown in the table do not require the filing of an estate tax return and will not have to pay any federal estate taxes.
A federal law, called the Economic Growth and Tax Relief Reconciliation Act of 2001, completely phased out the federal estate and GST taxes by 2010, leaving the gift tax in for 2010. In late 2010, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 was signed, resurrecting the federal estate tax and creating a $5 million exemption per person for 2011 and 2012 (indexed for inflation after 2011). In 2013, as a result of the American Taxpayer Relief Act, the $5 million exemption amount was made permanent with further inflation adjustments in following years. The top estate tax rate was set at 40%. The estate tax exemption is increased to $5.45 million in 2016.
The Tax Cuts and Jobs Act of 2017 significantly changed and adjusted several tax laws in 2017; one of the biggest changes was doubling the applicable exclusion to $10 million in 2018 (indexed for inflation to $11.2 million). For 2019, the inflation adjusted figure is $11.4 million. Under the Tax Act, however, beginning 2026, the exemption amounts will revert to pre-2017 amounts (indexed for inflation).
Your gross estate includes the value of all property in which you had an interest at the time of death. Your gross estate also will include the following:
- Life insurance proceeds payable to your estate or, if you owned the policy, to your heirs.
- The value of certain annuities payable to your estate or your heirs.
- The value of certain property you transferred within 3 years before your death.
- Trusts or other interests established by you or others in which you have certain powers.
Your gross estate minus these allowable deductions will determine your taxable estate:
- Funeral expenses paid out of your estate;
- Debts you owed at the time of death; and
- The marital deduction (generally, the value of the property that passes from your estate to your surviving spouse).
If your estate is large enough to warrant concern about federal estate and state inheritance taxes, you should consult with an estate planning specialist or an attorney specializing in estate tax law to discuss the tax ramifications.
State Inheritance Tax
State death taxes can include any combination of the following major categories:
- Estate taxes
- Inheritance taxes
- Pick-up taxes
A number of states impose estate taxes on any real estate and personal property owned by deceased residents within the state. One tax rate may apply to all assets in the estate, or the rate may vary depending upon how the property is distributed. For example, a state may impose a lower tax rate on property left to a child than on property left to a distant cousin. Since a few states are in the process of phasing out estate taxes, check with an estate attorney regarding the laws in your state.
In states with inheritance tax laws, the person who inherits the property must pay the taxes. This differs from estate taxes, which are paid from the decedent's estate. In this case, too, rates and exemptions may vary, depending on who received the property. For instance, the decedent's spouse may be taxed at a lower rate, if at all, than a friend of the decedent. A number of states are phasing out inheritance taxes, so check with an attorney regarding the laws in your state.
Most states, even if they have estate or inheritance tax laws, in practice follow what is known as a "pickup" system of taxation at the time of the decedent's death. Under this system, even though a state tax return must be filed on behalf of the estate or by a beneficiary who inherits property, the state's share of the tax comes out of what the estate pays to the Internal Revenue Service. In other words, in most states no additional tax needs to be paid beyond what is being paid to the federal government.
States differ their tax rates and deductibles when determining the amount of the taxable estate. As an example, California allows the following deductions:
- Property equal to the market value of decedent's separate property, if transferred to a surviving spouse;
- Decedent’s debts;
- Expenses of decedent’s last illness;
- Funeral expenses;
- State, county, and municipal taxes and assessments which are a lien at date of death;
- Administrative expenses;
- Property loss due to fire, earthquake, landslide or other casualty not compensated by insurance or otherwise, occurring after the decedent's death but prior to the order fixing the tax or prior to one year from the time of death (whichever is earlier).
Other states may have different rules about deductions and whether their tax rate is tied to the federal rate, so check with an estate attorney for more information about your state’s laws. State and federal estate taxes are generally paid directly out of the estate after death, regardless of whether the assets are transferred by will.