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What Are Death Taxes?
Death taxes, often known as estate or inheritance taxes, are levied on large estates upon the owner’s passing. In 2023, estates valued over $12.92 million are subject to federal estate taxes. This guide explores how these taxes work and offers strategies to reduce or avoid them entirely.
Key Takeaways
- Death taxes, also known as estate or inheritance taxes, are imposed on the transfer of assets from a deceased person’s estate.
- The federal estate tax in 2023 applies to estates worth over $12.92 million, with the rate ranging from 18% to 40%.
- Twelve states and the District of Columbia impose their own estate taxes separate from the federal government.
- Strategies like creating irrevocable trusts and making charitable donations can help reduce or avoid death taxes.
- The unlimited marital deduction allows spouses to transfer assets to each other tax-free, delaying estate taxes until the second spouse’s death.
How Death Taxes Work: Key Details
A death tax can be any tax imposed on property transfer after someone’s death. The term “death tax” gained popularity in the 1990s and was used to describe estate and inheritance taxes by those who wanted the taxes repealed. In estate taxes, the deceased’s estate pays the tax before the assets are transferred to a beneficiary. With the inheritance tax, the person who inherits the assets pays.
The estate tax, charged by the federal government and some state governments, is based on the value of property and assets at the time of the owner’s death. The federal estate tax ranges from 18% to 40% of the inheritance amount.
Twelve states, including Connecticut and New York, impose a state estate tax separate from the federal one.
The federal government does not impose an inheritance tax, but several states do—Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania; however, in all of these states, property passing to a surviving spouse is exempt from inheritance taxes. Nebraska and Pennsylvania impose taxes on property passing to a child or grandchild in some instances.
Death Tax Exemption Limits: 2023 and Beyond
Most people end up not paying the death tax because it applies to only a few people. This is because the 2017 Tax Cuts and Jobs Act applied the estate tax to the basic exclusion amount, which in 2023 is $12.92 million and in 2024 is $13.61 million.
Important
The Tax Cuts and Jobs Act, expiring after 2025, will result in the exclusion amount dropping if not renewed by Congress.
For example, assume an individual leaves an estate valued at $13 million (accounted for inflation) in non-exempt assets to the children and has never left any gifts that exceeded the exclusion amount. The amount above the federal level in 2023 ($13 million – $12.92 million), $80,000, will be subject to estate tax. According to the Unified Rate Schedule, the taxable amount is subject to a 28% tax plus a base tax of $18,200. Therefore, the estate will have a death tax liability of (28% x $80,000) + $18,200 = $40,600.
So, if a decedent’s estate is valued at less than the applicable exemption amount for the year of death, the estate won’t owe any federal estate taxes.
Unified Tax Credit: A Strategy to Lower Death Taxes
The unified tax credit has a set amount that an individual can gift during their lifetime before any death taxes or gift taxes apply. The unified tax credit combines gift and estate taxes into a single system, reducing the tax bill dollar for dollar.
Some prefer using the unified tax credit to save on estate taxes after death, rather than reducing gift taxes while alive.
Unlimited Marital Deduction: Tax Benefits for Spouses
Another provision available to reduce death tax is the unlimited marital deduction, which allows an individual to transfer an unrestricted amount of assets to their spouse at any time, including at the death of the transferor, free from tax.
This provision eliminates both the federal estate and gift taxes on property transfers between spouses, treating them as one economic unit. The transfer to surviving spouses is made possible through an unlimited deduction from estate and gift tax that postpones the transfer taxes on the property inherited from each other until the second spouse’s death.
Fast Fact
The unlimited marital deduction allows married couples to delay the payment of estate taxes upon the death of the first spouse because after the surviving spouse dies, all assets in the estate over the applicable exclusion amount will be included in the survivor’s taxable estate unless the assets are used up or gifted during the surviving spouse’s lifetime.
Weighing the Pros and Cons of Death Taxes
Advantages
- High threshold: The death tax affects estates over $12.92 million in 2023 and $13.61 million in 2024, so only the very wealthy need to worry.
- High tax revenue: As of July 21, 2024, for the fiscal year to date, the government has collected $25 billion in revenues from estate and gift taxes.
Disadvantages
- Double taxes: Those whose estates are large enough to trigger death taxes will be taxed twice—once with income taxes and once with the estate tax.
- Loopholes: There are ways to avoid paying estate taxes, so it is natural for those who have the assets to use these loopholes to avoid paying them.
Pros
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High threshold
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High tax revenue
Strategies to Minimize or Sidestep Death Taxes
Most won’t need to worry about death taxes as few have over $12.92 million in assets, even if the threshold drops to $5 million post-2025.
If you expect to have enough assets to trigger death taxes, here are ways to reduce or avoid them:
- Create an irrevocable trust: Consider placing your assets in an irrevocable trust to shield them from estate taxes. You could then have the trust distribute the funds to you and your beneficiaries as income, reducing your tax burden. The most common trust used in this tactic is a grantor retained annuity trust (GRAT).
- Give your assets to family and friends: You can give them away to relatives and friends tax-free as long as you don’t exceed the lifetime exclusion limit of $12.92 million ($25.84 million if you and your spouse give them away) in 2023 and $13.61 million ($27.22 million if you and your spouse give them away) in 2024.
- Enjoy your money: The best way to avoid estate taxes is to ensure you give enough away so that your family won’t struggle, then go out and enjoy the money you’ve worked hard for.
- Charitable donations: Giving away money to charitable organizations you believe in can be rewarding—you can also deduct contributions from your estate.
How Do You Avoid Death Taxes?
Most people will not incur estate taxes, commonly called the death tax. But if you have $12.92 million or more in assets in 2023 or $13.61 million in 2024, you can avoid paying taxes by donating to charity, giving enough of your estate away to reduce its value, or placing it in special trust funds.
What States Have Death Taxes?
Twelve states and one district have estate taxes—Connecticut, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Vermont, Washington, and the District of Columbia.
What Is the Difference Between an Estate Tax and an Inheritance Tax?
The estate of the deceased is responsible for estate taxes while the heirs of the deceased are responsible for inheritance taxes.
The Bottom Line
Death taxes, also known as estate or inheritance taxes, apply to estates valued over $12.92 million in 2023 and $13.61 million in 2024, impacting only a small percentage of the population. While the federal government does not impose an inheritance tax, some states do. It’s crucial for individuals with substantial estates to explore options for reducing tax liability, such as creating irrevocable trusts, making charitable donations, or utilizing the unified tax credit. Most individuals will not encounter death taxes, but those who might should take proactive steps to minimize potential taxes and ensure their estate planning aligns with their financial goals.
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