CashStock, bonds, and other securitiesBusiness interestsReal propertyTrusts and annuitiesInsuranceOther valuable assets
The total of all these assets is known as your “gross estate.” The fair market value of your assets is not necessarily what you paid for them. Instead, it’s what they are worth at the time of your death. The executor or administrator of the estate can also elect to have everything valued on an alternate date six months later, provided the assets aren’t “distributed, sold, exchanged, or otherwise disposed of within the six month period,” the IRS notes. Credits and allowable estate tax deductions are subtracted from your gross estate. These can include property you pass to charity, mortgage or other debts, and any costs and fees incurred to settle your estate. Only assets that are worth more than a certain threshold are taxed at a percentage of their value. This threshold is known as the “estate tax exemption.” For 2022 (the tax return you file in 2023), the estate tax exemption is $12.06 million. The rate at which your estate is taxed depends on how high over the exemption limit your assets are. The rate ranges from 18% for assets that up to $10,000 more than the exemption to 40% for estates that are $1 million or more above the exemption.
Who Is Subject to the Estate Tax?
The estates of all U.S. citizens and U.S. residents at the time of death are subject to the federal estate tax, but very few estates actually have to pay it because of the exemption. Only estates whose values exceed the exemption after deductions are made, and credits are taken, are subject to the federal estate tax on the balance.
History of the Estate Tax
The estate tax exemption was initially indexed for inflation under the provisions of the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (TRUIRJCA). This law also set the top estate tax rate at 35%. These provisions were supposed to remain in place until Dec. 31, 2012. At that point, the federal estate tax laws were supposed to revert back to the ones in effect before 2001. This meant that the federal estate tax exemption would drop all the way down to $1 million, and the tax rate would jump to 55% in 2013. Then Congress and President Barrack Obama acted in the early days of 2013 to pass the American Taxpayer Relief Act (ATRA). This law made permanent the TRUIRJCA changes to the rules governing estate taxes, gift taxes, and generation-skipping transfer taxes. In 2018, the Tax Cuts and Jobs Act (TCJA) more than doubled the 2017 exemption, which was already indexed to keep pace with inflation.
The Unlimited Marital Deduction
One of the most significant deductions for the estate of a married decedent is the unlimited marital deduction. Remember, the estate tax is based on an estate’s value after all available deductions and credits have whittled it down. In general, the marital deduction allows a decedent to take a deduction for all property in the gross estate transferred to the surviving spouse at death.
Estate Tax Portability
The Internal Revenue Code also provides for portability of the estate tax exemption between married couples. Portability means that if you are married and die before your spouse, you can pass any of your unused exemption to them to use for their own estate. For example, if your father left an estate worth $10 million when he passed away in 2021, he still had $1.7 million left after applying the 2021 exemption of $11.7 million. If your father was married at the time of his death, he can pass that remaining $1.7 million from his estate to his spouse. Now your father’s spouse can shelter $1.7 million more than whatever the estate tax exemption is at the time of their death. A federal estate tax return must be filed if the executor of the estate wants to give the portability bump to the surviving spouse, even if the decedent’s estate doesn’t owe a tax because its value doesn’t exceed the exemption amount. Submitting the form indicates that the portability option is being exercised; to opt out, the executor of your estate would have to check the box in Section A of Form 706.
How to File an Estate Tax Return
An estate must file a federal estate tax return, Form 706 when a gross estate exceeds the federal estate tax exemption for the year of the decedent’s death. Form 706 must be filed with the IRS within nine months of the decedent’s date of death. An automatic extension can be applied for by using Form 4768. Any tax amounts owed on the estate that aren’t paid by the due date will accrue interest.
Estate Tax vs. Inheritance Tax
Estate and inheritance taxes are two separate things, but they’re often confused. They are often lumped together under the unfortunate name “death taxes.” The estate tax is based on the value of a decedent’s entire estate after deductions, credits, and the estate tax exemption is subtracted and applied. It’s payable by the estate. An inheritance tax is payable by the beneficiary who receives property from the estate. It’s based on only the value of those inherited assets. It would apply if you inherit property, even if the estate were large enough to qualify for a federal estate tax. If you are the beneficiary, you are responsible for paying any inheritance tax. Some people include provisions in their wills to have the estate take care of this burden for their heirs. The federal government doesn’t impose an inheritance tax, but six states do as of 2020: Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania.
