The federal estate tax is a type of tax that applies only to large, valuable estates. It is levied when those estates’ assets pass from a decedent to their heirs and beneficiaries.
There is a federal estate tax that applies to all estates of a certain value (see below), and some states also implement their own estate tax. Here in Massachusetts, a separate state estate tax applies to those decedent’s estates that exceed $1,000,000, significantly smaller than those subject to the federal estate tax discussed below. Read more about Massachusettes Estate Tax.
The federal estate tax will not apply to the vast majority of people, but if you are wealthy and have a large estate, you could find yourself near or above the exemption limit. So, let’s take a look at everything you should know about the federal estate tax and how it could affect your estate planning.
Estate Tax Exemption Limits
As of 2020, the exemption limit for federal estate taxes is $11.8 million, up from $11.4 million in 2019. That exemption limit doubles for married couples. What this means is the federal estate tax is only applied to an estate’s fair market value that exceeds that exemption limit; everything up to that point can be passed on to your heirs tax-free.
When the Tax Cuts and Jobs Act was enacted into law in December 2017, it significantly increased the federal exemption limit for the estate tax, which previously had been set at $5.49 million. This allowed many people whose estates had previously been on the cusp of the exemption limit to breathe a little easier and avoid having to take steps to shrink their estate value.
Federal Estate Tax Rates
The rates you can expect to pay for an estate tax vary based on the taxable value of your estate. The highest marginal rate is 40 percent, applicable for people whose estate value is greater than $1 million over the exemption limit. So, for an individual, that means all value over $12.8 million would be taxed at 40 percent.
There are 12 “brackets” and different marginal rates in total, and the higher your estate value, the higher the marginal rate you will pay.
Estate Tax vs. Inheritance Tax
It should be noted that there is a difference between the estate tax and the inheritance tax.
The estate tax is a tax for the privilege of transferring property to heirs, and the deceased party’s estate is liable for paying the tax.
The inheritance tax is a tax on the privilege of receiving property from the deceased, and the heir is responsible for the tax instead of the estate. Inheritance taxes are not levied at all on the federal level, but there are six states that have an inheritance tax: Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. Massachusetts does not have an inheritance tax.
Steps to Reduce Federal Estate Tax
If your estate is near or exceeds the estate tax threshold, we suggest that you contact an estate planning attorney to determine if, and how, you can lawfully reduce your tax liability.
Baker Law Group offers an integrated approach to financial planning and estate planning. Contact us for more information about planning your estate around the estate tax.
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