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Understanding Estate Tax and How it Affects You

We all know that paying taxes each year that we are alive is to be expected. However, the federal government levies a tax when you die based on the value of the estate that you leave behind. Some states also collect an estate tax. Here are some things to know.

What is Estate Tax?

Your estate is everything that you own. This includes art, cash, land, financial investments, insurance, jewelry, real estate, royalties, and any other possessions that contribute to your net worth. Assets can be both tangible and intangible.

Once you pass away, the federal government assesses the fair market value of your assets. Depending on the state that you reside in, your state’s government may do that, too. This tax is sometimes called a death tax.

Not everyone will pay an estate tax. The tax is applied only on assets over a particular dollar amount. Some details of estate tax include:

● Federal estate taxes are applicable for estates valued at over $12.06 million (for 2022). Taxes must be paid for any amount over the current year’s threshold. The minimum threshold changes from year to year.

● State and district estate tax minimum thresholds vary from state to state. For instance, currently in Oregon the threshold is $1 million but in Connecticut it is a little over $7 million. Assets valued over the threshold are subject to state estate taxes.

● Currently, twelve states impose an estate tax in addition to federal estate tax.

● Estate taxes are collected before the distribution of any assets to beneficiaries.

● Assets that are transferred to a surviving spouse are not subject to estate tax. Other relatives that inherit may be subject to inheritance tax.

Estate Tax Versus Inheritance Tax

Many people equate estate tax with inheritance tax but they are two different things! The inheritance tax is what the inheritor, or beneficiary, must pay after receiving assets from a deceased benefactor. While there is no federal inheritance tax, several states do collect either an inheritance tax, estate tax, or both.

Some details on state inheritance tax include:

● Currently, six states impose an inheritance tax: Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania.

● Inheritance tax is dependent on where the deceased resided, not where the beneficiaries live.

● Tax rates vary from state to state and can be anywhere from 1% to 18%.

● Inheritance tax does not apply to assets received by a surviving spouse.

● Depending on the state, assets received by the deceased’s children and grandchildren might not be taxed, but those given to other relatives normally are.

Inheritance Tax Versus Gift Tax

Another common misunderstanding is thinking that inheritance tax and gift tax are the same thing. They are very different. While inheritance taxes apply when receiving assets from a deceased benefactor, gift taxes apply when receiving assets from someone who is still alive.

A few details regarding gift tax include:

● This is a federal tax that the giver of the gift must pay when giving cash, property, or something of value to someone else.

● Gifts up to $16,000 per year per person are not subject to gift tax.

● Anything gifted to one person above $16,000 will need to be documented with a gift tax return. And anything gifted over $16,000 may or may not be taxed as it depends on the size of the estate.

● Gifts to the donor’s spouse, political and charitable organizations, or those used for another’s medical or educational expenses are not subject to gift tax.

Estate Tax Exemption

You may be thinking that you don’t have to worry about estate taxes because your assets are not over the current $12.06 million threshold. Not so fast! The thresholds change from year to year, and they are set to be lowered by fifty percent starting on January 1, 2026.

Normally, the federal estate tax exemption, or threshold amount, increases each year to keep up with inflation. In 2026, the estate tax exemption will drop down to between $6 to 7 million (adjusted for inflation), meaning that any estates valued over that amount will be subject to federal estate tax. Depending on whether current proposed bills pass Congress or not, the federal estate tax may plunge even further.

Actions to Take Now

Regardless of the size of your estate, it is smart to take measures now to protect your assets from being eaten up by federal and state taxation. Obviously, you cannot control what government laws do, but you can control your decisions and actions to safeguard your hard earned money.

Some actions include:

  1. Give some of it away. Gift assets to family or other beneficiaries while you are still alive. There is no limit to how many people you can gift to and provided that the amount isund er the gift tax threshold, no tax will be levied.

  2. Make charitable donations. You will not only lower the value of your estate, but will also receive a tax break.

  3. Move. Consider moving or establishing residence in a state that does not have estate or inheritance tax.

  4. Do your research and make wise choices. Being informed is a good start. Consult with a financial advisor to help you fine-tune your choices and decisions.

  5. Set up a trust. Establishing a charitable remainder trust or charitable lead trust can reduce the size of your estate and the chances of paying estate taxes.

In Summary

There is a lot to think about when it comes to estate taxes and exemption from them. Consulting with professionals who specialize in this area, such as tax attorneys, CPAs, and financial advisors is a smart way to protect you and your family from unnecessary taxation. If you have any questions as you digest the ins and outs of estate taxes, please know that we are here to help.

Written by Matthew Delaney


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