The estate tax is a tax levied on large estates when assets pass from the decedent to beneficiaries. There is a federal estate tax, and several states have their own estate taxes. In either case, the tax only applies to estates over a certain size. If you’re very wealthy, you’ve probably started thinking about the estate tax already. But even if you’re not among the 1%, you might still find your estate subject to the tax, so it pays to know the details.
Estate Tax Basics
The estate tax is just what it sounds like: a tax that the government levies on estates when you pass away and pass on your assets to heirs. If your estate has a high enough value after you pass away, then you’ll have to pay estate taxes on anything you’re looking to bequeath. This could include cash, real estate, retirement accounts or a range of other assets.
Currently, the threshold for federal estate taxes is $11.8 million, up slightly from the 2019 threshold of $11.4 million. Each state has its own threshold as well, as we’ll explore in more depth later on.
Estate Tax Rates
If your estate is under $11.8 million, congratulations: The federal estate tax will not apply to your estate. Any amounts over that threshold will be taxed at the following marginal rates (your “taxable estate” refers only to the amount of your estate that exceeds the $11.8 million cutoff).
|FEDERAL ESTATE TAX RATES|
|Taxable Estate*||Base Taxes Paid||Marginal Rate||Rate Threshold**|
|$1 – $10,000||$0||18%||$1|
|$10,000 – $20,000||$1,800||20%||$10,000|
|$20,000 – $40,000||$3,800||22%||$20,000|
|$40,000 – $60,000||$8,200||24%||$40,000|
|$60,000 – $80,000||$13,000||26%||$60,000|
|$80,000 – $100,000||$18,200||28%||$80,000|
|$100,000 – $150,000||$23,800||30%||$100,000|
|$150,000 – $250,000||$38,800||32%||$150,000|
|$250,000 – $500,000||$70,800||34%||$250,000|
|$500,000 – $750,000||$155,800||37%||$500,000|
|$750,000 – $1 million||$248,300||39%||$750,000|
|Over $1 million||$345,800||40%||$1 million|
You’ll pay the indicated rate for all taxable income that falls into that bracket, plus the base tax (which is the sum of all the taxes you paid in the prior brackets). For instance, if your estate is valued at $11,470,000, your total taxable estate is $70,000; you’ll pay the base rate of $13,000, plus an additional $2,800 (the $10,000 in this bracket, taxed at 28%), for a total tax of $15,800. The current federal estate tax rate maxes out at 40% for taxable amounts greater than $1 million.
Estate Taxes vs. Inheritance Taxes
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 six 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 an undeclared naval war with the new French republic. 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. This is despite the small percentage of households affected by what opponents of estate taxes tend to call “death taxes.”
The Estate Tax Exemption
Since 2013, the IRS estate tax exemption indexes for inflation. It took a big jump because of the new tax plan that President Trump signed in December 2017.
For tax year 2017, the estate tax exemption was $5.49 million for an individual, or twice that for a couple. However, the new tax plan increased that exemption to $11.18 million for tax year 2018, rising to $11.4 million for 2019 and now $11.8 million for 2020. 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
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. This could be 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 – the regular estate tax followed by 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. This ensures that the same assets aren’t taxed twice.
State Estate Taxes
If you die in certain U.S. states, your estate may also be subject to a state estate tax. 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 in those states will face estate taxes at both the federal and state level. These thresholds range from $1 million in Orgeon and Massachusetts, to $11.4 million in multiple states that match the federal exemption. Rates also vary; if you live in one of these states, you’ll need to figure out how much you can expect to pay based on state rates and where your taxable estate falls.
Additionally, six states levy an inheritance tax, separate from the estate tax. These states are Nebraska, Iowa, Kentucky, Pennsylvania, Maryland and New Jersey. Maryland is the only state in the country that levies both an estate tax and an inheritance tax. The key difference between an inheritance tax and an estate tax is who’s responsible for paying. With an estate tax, the estate is responsible, but with an inheritance tax, the beneficiary is responsible. Spouses are exempt from paying the inheritance tax in all six of these states, and some states extend that exemption, at least partially, to all immediate relatives.
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.
Tips for Planning Your Estate
- Estate planning can be a complex process, and that’s especially true if you’re someone with significant wealth. To make sure you have everything you need, read up on the must-have estate planning tools for wealthy investors.
- If you’re looking for professional assistance in navigating the estate-planning process, consider working with a financial advisor. SmartAsset’s financial advisor matching tool can connect you with an expert in your area. Just answers some questions about your finances and goals, and the tool will pair you with up to three local advisors.
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