Taxes are never pleasant to think about, especially taxes that involve your death or the death of family members. Estate taxes and inheritance taxes, sometimes referred to as “death taxes,” occur when there is a transfer of assets upon someone’s death. It is important to understand whether the estate or inheritance tax applies to you and to plan accordingly. To start, the estate tax and inheritance tax are not the same.
What Is the Estate Tax?
The estate tax is a tax on your right to transfer property at your death (IRS.gov). This “property” is inclusive of cash, securities, real estate, business interest -- practically all assets you own. The total value of these assets is your gross estate, which will be the starting point for what is taxable in your estate. [1]
Who Pays for Estate Tax and Does It Apply to You?
The estate pays the estate tax. This is an important part of the estate planning process as you need to make sure the estate will have the ability to pay for the tax. This is particularly important if you have illiquid assets in your gross estate, like business interest.
The estate tax only applies when your gross estate exceeds a certain threshold. For 2021, the threshold is $11.7 million ($23.4 million for married couples).[1]
As such, the estate tax is primarily a concern for the wealthy; however, it is important to stay up to date with current tax laws related to estate taxes. Under current law, the threshold will revert to 2017 limits ($5.49 million) adjusted for inflation at the end of 2025.
More recently, there have been proposed tax law changes to reduce the threshold as early as 2022. Accordingly, the estate tax is likely to end up affecting more Americans. If that includes you, it is particularly important to consider your current estate plan to take advantage of the current law’s higher threshold.
Additionally, certain states have estate taxes, including their own exemption thresholds. In 2021, these states include:
Connecticut
Hawaii
Illinois
Maine
Maryland
Massachusetts
New York
Oregon
Rhode Island
Vermont
Washington
Washington, D.C.
What Is the Inheritance Tax?
The inheritance tax is similar to the estate tax in concept as it occurs when assets are transferred upon death; however, it is only taxed at the state level. There is no federal inheritance tax. For each applicable state, the taxation rules are different and can be quite varied.
Who Pays the Inheritance Tax and Does It Apply to You?
The beneficiaries of the inheritance pay the inheritance tax. Whether (and how much) the inheritance tax applies to you will vary by the state you live and file your taxes in. In 2021, the states that impose an inheritance tax include:
Iowa
Kentucky
Maryland
Nebraska
New Jersey
Pennsylvania
When Should You Start Planning for Estate and Inheritance Taxes?
The sooner, the better! Whether you are an owner of the estate or a future beneficiary of the estate, it is important to plan well before the transfer of the estate occurs. Failure to plan can be very costly and time-consuming. Your wishes, including any potential early inheritance, can become part of your comprehensive legacy plan.
How Do You Plan for Estate and Inheritance Taxes?
Create an estate plan. Estate planning can be complicated, so consider working with a financial advisor whose services include estate planning or legacy planning.
There are many different strategies to reduce your future estate and inheritance taxes, and multiple licensed professionals need to be involved throughout the different steps of the estate planning process.
A good financial advisor can alleviate the burden of estate planning and provide you with the peace of mind that your wishes will be fulfilled when you pass. If you are receiving an inheritance, they can help you use your inheritance to achieve your goals while honoring the memory of your loved one.
[1] Internal Revenue Service. “Estate Tax” Internal Revenue Service. Accessed October 7, 2021. https://www.irs.gov/businesses/small-businesses-self-employed/estate-tax.
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