Taxes owed on a family member's estate after the death can be very high. This tax is called an estate tax, inheritance tax, and death tax. Up to a certain amount (i.e., the estate's value), taxes are not owed. After that amount is surpassed, taxes are owed by those inheriting the estate. We'll go over the estate tax details in this article, who pays it, and how much they'll pay.
What Is an Estate Tax?
An estate tax is a tax owed on the property's value above certain thresholds. For 2021, that threshold is $12,060,000. The amount is double for married couples.
The tax bill can be significant depending on how much of the estate is over the threshold. For 2018, the effective tax rate was 16.5%. That might seem fairly low, but on $5 million, it comes to $825,000. We'll see how the estate tax is calculated in the next section.
Estate taxes contribute to federal and state (where applicable) revenue, which means governments can use the money for infrastructure, public services, and other areas.
Paying Estate Taxes
Even if someone has a large estate, it doesn’t mean their heirs will have to pay taxes. If the estate is below the tax threshold, it can be passed on tax-free. As mentioned above, the estate tax exemption threshold for 2022 is $12.06 million, and for 2021 it is $11.7 million at the federal level.
For those who are married, if a spouse dies, their exemption can be given to the other spouse, which doubles the exemption. In that case, the total exemption is $24.12 million.
Any amount of the estate above the threshold will be taxed at 40% (federal level).
In addition to the federal estate tax, some states have a state-level estate tax. State-level estate taxes can be progressive. The tax rate will change at different asset levels until it peaks out. For example, a state may tax 10% up to $2 million, then 12.5% up to $5 million, then 15% up to $7.5 million, and top out at 20% up to $10 million.
Some states also do not allow a spouse to give their exemption to the other spouse.
One strategy some people use to reduce the tax burden on their heirs is to purchase life insurance worth the approximate value of the estate tax that will be owed. The life insurance policy is put into an irrevocable life insurance trust. The trust is irrevocable to prevent taxes from being owed on the life insurance. Basically, the life insurance policy is kept out of the estate. Upon the estate owner’s passing, the life insurance is paid out to the trust.
While the above is not the only strategy for saving on estate taxes, it’s best to work with a real estate tax attorney when planning any potential tax savings.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation. Examples shown are hypothetical and for illustrative purposes only.