The idea of the estate tax, or death tax as it’s sometimes known, is scary for many Americans. However, the real truth is that the vast majority of people will never encounter it. That’s because the federal estate tax has an extremely high exemption amount, which is $12.92 million. So if your estate is worth less than that 2023 exemption amount, you won’t owe any federal estate taxes. There are taxes levied by some states to contend with in certain parts of the country, though. For help with your estate plan, consider working with a financial advisor.
What Is the Estate Tax?
The estate tax is a federal law that dictates that estates worth more than the current year’s exemption pay a certain amount of tax on any value above the exemption. For 2023, the federal estate tax exemption is $12.92 million ($25.84 million for couples). That means if your estate is worth less than that at the time of your death, you won’t owe any taxes.
That $12.92 million exemption above means estates can subtract that amount from their total if they’re worth more than that. So if an estate has a $15 million value, it will only pay estate taxes on the $2,080,000 above the exemption. If your estate surpasses the exemption, here are the tax rates you’ll pay:
2023 Federal Estate Tax Rates
|Taxable Amount||Estate Tax Rate||What You Pay|
|$1 – $10,000||18%||– $0 base tax|
– 18% on the taxable amount
|$10,001 – $20,000||20%||– $1,800 base tax|
– 20% on the taxable amount
|$20,001 – $40,000||22%||– $3,800 base tax|
– 22% on the taxable amount
|$40,001 – $60,000||24%||– $8,200 base tax|
– 24% on the taxable amount
|$60,001 – $80,000||26%||– $13,000 base tax|
– 26% on the taxable amount
|$80,001 – $100,000||28%||– $18,200 base tax|
– 28% on the taxable amount
|$100,001 – $150,000||30%||– $23,800 base tax|
– 30% on the taxable amount
|$150,001 – $250,000||32%||– $38,800 base tax|
– 32% on the taxable amount
|$250,001 – $500,000||34%||– $70,800 base tax|
– 34% on the taxable amount
|$500,001 – $750,000||37%||– $155,800 base tax|
– 37% on the taxable amount
|$750,001 – $1 million||39%||– $248,300 base tax|
– 39% on the taxable amount
|$1 million+||40%||– $345,800 base tax|
– 40% on the taxable amount
Most states do not have an estate tax, but a handful does. More specifically, estates of residents of Hawaii, Washington, Oregon, Minnesota, Illinois, Vermont, Maine, New York, Massachusetts, Rhode Island, Connecticut, Maryland and Washington, D.C. may be subject to estate taxes. Exemption amounts vary by state.
What Is Inheritance Tax?
In addition to the estate tax, some states have inheritance taxes that beneficiaries of estates may need to pay. It is similar to the estate tax but is levied on the other side of the assets passing through to a new party. Inheritance taxes are less common than estate tax but they are required in some states.
The states that require an inheritance tax include Nebraska, Iowa, Kentucky, Pennsylvania, New Jersey and Maryland. Maryland is the only state to have both estate and inheritance taxes.
How to Avoid the Estate Tax
As you might expect, most people aren’t exactly thrilled at the proposition of paying estate taxes after their death. In turn, there are several strategies you can use to minimize what you owe or avoid estate taxes altogether. Below, we review several different ways you can avoid the estate tax if you expect your estate to owe.
1. Give Gifts to Family
One way to get around the estate tax is to hand off portions of your wealth to your family members through gifts. For 2023, you can give any one person up to $17,000 tax-free (or up to $34,000 if you’re married and you’re filing joint tax returns). Throughout your lifetime, you can give out up to $12.92 million (for 2023) of your wealth as gifts before getting hit with the gift tax.
There’s no limit to the number of people you can give gifts to within a single year. So if you have an $18 million estate, you can gradually pass on your assets to your loved ones until the net value of your estate is less than (or equal to) $12.92 million. Just keep in mind that this threshold applies to both the gift tax and estate tax at the same time.
2. Set Up an Irrevocable Life Insurance Trust.
If you don’t want to leave your family members in a difficult financial situation after you die, it’s a good idea to buy life insurance. Life insurance proceeds generally aren’t taxable. But after you pass away, they could become part of your estate, which is subject to taxation.
To avoid having your life insurance proceeds taxed, you can create an irrevocable life insurance trust. You’d essentially be setting up a trust and transferring the ownership of it to another person. The trust is irrevocable because, in the future, you wouldn’t be able to make adjustments to it without the consent of the trust’s beneficiary.
By transferring over your life insurance policy, your death benefits wouldn’t be part of your estate. It’s best to do this sooner rather than later, however. If you die within three years of making the transfer, your life insurance proceeds would still be considered part of your taxable estate.
3. Make Charitable Donations
Another way to bypass the estate tax is to transfer part of your wealth to a charity through a trust. There are two types of charitable trusts: charitable lead trusts (CLTs) and charitable remainder trusts (CRTs).
If you have a CLT, some of the assets in your trust will go to a tax-exempt charity. By donating to charity, you’ll lower the value of your estate and end up with an extra tax break. Once you die (or after a pre-determined period of time), whatever’s left in the trust will be passed on to your beneficiaries.
On the other hand, if you have a CRT, you can transfer stock or another appreciating asset to an irrevocable trust. Throughout your lifetime, you can make money off of that asset. And then when you die, your investment income will go to charity. In the process, you’ll avoid the capital gains tax and lower your estate tax burden. Plus, you’ll score a tax deduction.
4. Establish a Family Limited Partnership
If there are any family-owned businesses or assets (such as properties) that you want your children to own after you’re gone, you can set up a family-limited partnership. Typically, this involves establishing a general partnership and then making heirs and family members limited partners.
As the general partner, you’ll still be able to call the shots. But your partners (whether they’re your children or another relative) will have a stake in your company or own a portion of your assets. As a result, the size of your estate will be smaller.
5. Fund a Qualified Personal Residence Trust
An additional way to reduce the number of assets that will be subject to the estate tax is to fund a qualified personal residence trust (QPRT). With a QPRT, you’re transferring the ownership of your home into a trust. During the trust’s term, you can continue living in your home without paying rent. After that term ends, your beneficiaries can take over your property.
Through a QPRT, you can freeze your primary residence and/or vacation home’s market value and avoid paying the gift tax (as long as you haven’t exceeded the lifetime limit for taxable gifts). You’ll also immediately reduce the size of your estate.
Unfortunately, if you die before the end of your trust’s term, your home will still be part of your estate. And while you can create trust for your house with a mortgage, it’s easier to set up a QPRT for a rental property.
How to Avoid Inheritance Taxes
If you’re inheriting an estate instead of transferring assets to someone else when you pass, then it’s important to understand what taxes you may need to pay as well. Only six states currently require an inheritance tax but if you’re in one of those states then it’s important to know how to limit what you may be required to pay. There are two major ways to avoid inheritance taxes:
- Move to a state that doesn’t require inheritance taxes
- Work with the owner of the estate before their passing to avoid potential taxes
The owner of the estate can write a will or put the assets in a trust with you as a beneficiary that may be able to help with taxes. The best thing you can do is to consult with a financial advisor as early on in the process as possible to see what can be done to avoid any potential taxes that don’t need to be necessary for your situation.
The Bottom Line
Very few people will ever have to worry about estate taxes. But if you inherit millions of dollars and you’re worried about dealing with the death tax, you can get around it and lower your tax burden if you plan ahead and make the most of some of the tax loopholes that benefit the wealthy.
Estate Planning Tips
- A financial advisor can help you optimize your estate plan. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Although estate plans generally include wills, they are much, much more than that. To learn more, read through SmartAsset’s guide to estate planning vs. wills.
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