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All About the Estate Tax

If you’re very wealthy, you’ve probably started thinking about the estate tax already. But even people whose assets don’t reach into the millions should know about estate taxes in the state where they live. It’s not just federal estate tax that can eat into your heirs’ inheritance – it’s state-level taxation as well. Want to learn more? You’ve come to the right place.

Check out our federal income tax calculator.

Estate Taxes vs. Inheritance Taxes

What is the estate tax? IRS estate taxes are taxes on the privilege of transferring property to your heirs. It’s the estate of the deceased that is liable for the tax. An inheritance tax, by contrast, is a tax on the privilege of receiving property from a deceased benefactor. The (living) heir pays an inheritance tax, not the estate of the deceased. There is a federal estate tax and, in some states, a state estate tax. Inheritance taxes, though, are not levied at the federal level. Only a handful of states have inheritance taxes.

The History of the “Death Tax”

The history of estate taxes in the US is tied to the history of war. The first tax resembling an estate tax was levied in the 1790’s to help raise funds for fighting the French. Rather than being a tax on estate assets directly it was a tax on wills and probate forms. This tax was only temporary. In the 1860s the Civil War prompted a new estate tax, again to raise money for the war effort. Again the tax lapsed and again it was revived, this time in the 1890s. The 1890s incarnation of the estate tax had two goals: 1) to tax some of the money being made by wealthy industrialists who were getting off easy under the old tax system and 2) to raise money for the Spanish-American War.

What we now think of as federal estate taxes became law in 1916, when WWI created an urgent need for more government revenue. Since then, estate taxes have been a source of political controversy, despite the small percentage of households affected by what opponents of estate taxes tend to call “death taxes.”

Estate Tax Rates

The current federal estate tax rate (or death tax rate, depending on how you see things) stands at 40%.

The Estate Tax Exemption

All About the Estate Tax

Since 2013, the IRS estate tax exemption has been indexed for inflation. It took a big jump  for 2018 though because of the new tax plan that President Trump signed in December 2017.

For tax year 2017, the estate tax exemption is $5.49 million for an individual, or twice that for a couple. However, the new tax plan will increase that exemption to $10 million for tax year 2018. If your estate is in the ballpark of the estate tax limits and you want to leave the maximum amount to your heirs, you’ll want to do some estate tax planning.

If you’re in charge of paying estate taxes for a deceased loved one, you might want to enlist a tax account and/or an estate lawyer to help you shoulder that burden. In addition to estate taxes, you may need to file separate income taxes for the deceased if the deceased’s estate is generating income above IRS limits. To file a US estate tax return, you’ll need a tax ID number for the estate. An estate’s tax ID number is called an “employer identification number,” or EIN. You can apply for a number online, by mail or by fax.

If you want to limit your exposure to the estate tax you might want to start giving some money away. You can make a charitable donation (and deduct it at tax time) or give to the heirs whose inheritance would otherwise take a hit from estate taxes. If you give up to $15,000 a year ($14,000 for tax year 2017) you can whittle away at your estate. This is known as the annual gift tax exclusion. Each single filer or member of a married couple can give up to $15,000 – and not just to one person each. That $15,000 limit applies to as many people as you want. If you give more than $15,000 to any one beneficiary you will have to pay the federal gift tax rate, which is the same as the estate tax rate – 40%.

On the Estate Tax Deduction

All About the Estate Tax

The estate tax deduction is the IRS’s way of preventing double taxation. Sometimes, the estate of a deceased will have income coming its way, such as for a property sale that hasn’t gone through by the time the owner dies. That kind of income is known as Income in Respect of Decedent (IRD). A large estate might face double taxation at the federal level. First, the regular estate tax and second, the income tax on the IRD. The estate tax deduction lets you deduct the portion of the estate tax paid for the IRD from the income tax on that IRD, thereby ensuring that the same assets aren’t taxed twice.

Related Article: The Lowest Taxes in America

State Estate Taxes

If you die in certain US states the value of your estate will suffer for it. Washington, Oregon, Minnesota, Illinois, Maryland, Vermont, Connecticut, New York, Rhode Island, Massachusetts, Maine, Hawaii and Washington, D.C. all levy estate taxes.  That means that the estates of people who live in those states (or D.C.) whose assets are above the threshold for taxation will be taxed at both the federal and state level. Other states, like Kansas, Mississippi and West Virginia, don’t have estate tax. Of course, having both federal and state taxes is common with income taxes. It’s rare with estate taxes. If you live in one of the states that has its own estate tax, that will mean less money for your heirs. Are you a resident of one of the places listed above? You (well, technically your beneficiaries) have even more to gain from some thoughtful estate planning and advanced gift-making.

Related Article: The 7 States with the Highest Death Taxes

Bottom Line

The vast majority of Americans won’t die with estates large enough to trigger the estate tax. Part of the reason estate taxes are unpopular, though, is that most of us like to think we could become rich someday, and that if we did become rich we’d want low estate taxes.

Photo credit: © iStock/kodachrome25, © iStock/DNY59, © iStock/alexskopje

Amelia Josephson Amelia Josephson is a writer passionate about covering financial literacy topics. Her areas of expertise include retirement and home buying. Amelia's work has appeared across the web, including on AOL, CBS News and The Simple Dollar. She holds degrees from Columbia and Oxford. Originally from Alaska, Amelia now calls Brooklyn home.
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