About 0.2% of estates owe federal estate taxes.
The advantages of accumulating wealth may be offset by the possibility that part of your estate will be vulnerable to federal taxation. That happens if the estate’s total value is larger than the exempt amount that you can transfer tax-free.
While the primary focus in creating an estate plan is ensuring that your property goes to the people and organizations you want to benefit, limiting the potential tax bill is also important.
Who pays estate taxes?
Your estate will owe federal estate taxes if you die in 2021 if your taxable estate is larger than $5.43 million. That includes about 0.2% of all estates. If you’re married, the same is true for your spouse, so together you can leave an estate worth $10.98 million. In fact, if your estate doesn’t need the full exemption, any excess is portable and can be added to your surviving spouse’s $5.49 million exemption.
However, if you’ve made taxable gifts in your lifetime, those gifts count as part of the $5.49 million tax-free total unless you’ve already paid the tax that’s due on those amounts. Taxable gifts are amounts over $14,000 you give to a single person in the course of a year.
The highest federal rate your estate will pay on its taxable value is 40%, which is just slightly more than the highest rate on ordinary income, which is 39.6% in 2017.
However, many states also tax estates. In some cases, the rates exceed 15% and the exempt amount is $1 million or less. You should consult your tax adviser and estate attorney about the state taxes that may apply and take that potential cost into account in your long-term planning.
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Saving taxes
Although the size of the estate you can leave tax-free has increased, the value of what you own may have increased too. Not only should you keep careful track of what your estate is worth, but you should have an estate plan in place to avoid, or at least minimize, these taxes. It’s smart to create your plan with your professional advisers since the rules and regulations are complex. But the more you know about what you want to achieve, the easier and probably cheaper it will be to move ahead.
A separate identity
Because an estate has an identity separate from the person whose property it was and from that of the executor, it needs its own federal ID number and its own bank account. Executors can apply for the number from the IRS using Form SS-4.
The plan you create should let you take advantage of several of these money-saving options:
- If you’re married, you can use the marital deduction to leave everything in your estate to your spouse tax-free if he or she is a US citizen
- You can reduce the size of your estate by making annual tax-exempt gifts
- If you’re married and your spouse agrees, you can each make an annual tax-free gift, effectively doubling the amount, even if only one of you has earned the money
- You can make annual tax-exempt charitable gifts equal to half your adjusted gross income in most cases
If your spouse dies first, you’re entitled to carry over any portion of estate tax exemption he or she didn’t need to increase the amount you can leave tax-free. But you must elect this feature, called portability, on the estate tax return of the first to die.
Estate tax
Estates valued at less than the exempt amount
PAY NO ESTATE TAX
Estates of any size, left to US citizen spouse
PAY NO ESTATE TAX
Estates valued over the exempt amount left to anyone but spouse
PAY ESTATE TAX
How to figure estate tax?
First, determine the value of the gross estate Then, subtract the estate’s expenses and reductions to find the
Taxable estate
Next, figure the tax amount due on the value of the taxable estate
Finally, subtract the credits that apply to find the net estate taxes.
Paying estate taxes
If estate taxes are due, the estate itself must pay them within nine months of your death, in most cases. It’s your job, though, to anticipate the tax bill and plan so that there’s enough money to pay it. If the estate doesn’t pay when the tax is due, your heirs may be liable for the taxes themselves. That might mean having to sell assets at a loss, or tapping their own savings to meet the obligation, which is probably not what you intended in making them your beneficiaries.
Taking different bites
Estate taxes are taxes on the property’s value in your estate, and the estate usually pays them. There’s a federal estate tax and, in some states, a state estate tax. Inheritance taxes are state taxes your heirs pay for the value of the property they receive from your estate. You can specify in your will that your estate should pay whatever inheritance taxes are due to save your heirs from having to sell the property they inherit to be able to pay the tax.
To ensure there’s money available in your estate to pay the taxes, you can leave instructions for liquidating, turning into cash, specific assets, or selling your share of a business. The best method of coming up with money depends on your financial situation. But don’t assume that decisions that seem obvious to you will be just as clear to someone else. It’s a good idea to get tax and legal advice and then spell out what you think should happen in a letter of instruction to your executor or your heirs.
Residence and domicile
Federal estate taxes are figured at the same rate no matter where you live. But where you hang your hat can make a big difference when it comes to state taxes. For starters, real estate and tangible personal property are taxable in the state where they’re physically located, whether you are a resident of that state or not. Intangible personal property — stocks, for example — are taxable in the state of your legal residence or domicile. There can only be one of those, no matter how many residences you have.
If there’s a question about your domicile, documents showing where you voted, maintained bank accounts, registering your car, or the residence you declared in your will can be used to prove which place you considered home. One thing you should check while you’re able to is the consequence of owning property in different states. You might decide to make some changes to save taxes, or legal fees, or both.
Estate Taxes. How Much Should You Pay? by Inna Rosputnia
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