What You Should Know About Estate Taxes

August 17, 2020 | by Jacob Hamilton

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When you pass away, the wealth you leave behind might be taxed. Whether or not your estate value is reduced by taxes depends on a variety of factors, including where you live and how much wealth you've left behind. Estate taxes allow the federal or state governments to take a calculated amount of your wealth—which could mean less for your family. Find out more about estate tax deductions and other tools that can help ensure your loved ones receive more of the value from your estate.

What Is an Estate Tax?

An estate tax is simply a tax that is levied on the value of your estate. In other words, depending on how much you leave your loved ones when you're gone, the federal and state governments might take their cut.

The estate tax is not paid by your beneficiaries, which are the loved ones you leave money to. Instead, it's paid out of the proceeds of your estate. Once all the estate taxes and debts are paid, what's left is distributed to your beneficiaries.

How Is an Estate Tax Different From an Inheritance Tax?

The biggest difference between an estate tax and an inheritance tax is who pays it. An inheritance tax is paid by the beneficiary. As of early 2020, only six states levied an inheritance tax. Those are Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania.

Federal Estate Taxes

The federal government's estate tax only hits around 0.2% of estates due to the high thresholds involved. For example, if the person passed away in 2020, their estate would have to reach a value of $11,580,000 before the federal estate tax came into play.

In most cases, you don't have a legal obligation to file a federal estate tax return if the estate doesn't meet this threshold. However, if there's a surviving spouse, you may want to file an estate tax return because the estate tax exemption is portable.

For example, two married people each have an exemption of $11,580,000. If a husband passes away in 2020 and his estate is worth $9,000,000, there's no need to file a return. However, if the estate does file the return, it can claim the difference between $11.580 million and $9 million for the wife's future exemption. That means she would have $2.58 million in extra exemption above whatever the threshold was for a given year.

Although most of us don't have estates worth $9 million or more, filing the paperwork and claiming the extra exemption for the future may be beneficial. Since the federal government can change exemptions at any time, filing might come in hand.

Because exemptions and estate tax laws change regularly, it's a good idea to consult a professional such as a CPA or tax attorney. You need to decide what's best for your situation, and that can depend on many factors—not just the total value of the estate.

State Estate Taxes

Not all states levy an estate tax, but those that do have a threshold lower than the federal amount. That means you could owe state estate tax even if you don't have to file a federal estate tax return.

States that have an estate tax as of 2020 include:

  • Connecticut: estates larger than $5.1 million
  • District of Columbia: estates larger than $5.68 million
  • Hawaii: estates larger than $5.49 million
  • Illinois: estates larger than $4 million
  • Maine: estates larger than $5.8 million
  • Maryland: estates larger than $5 million
  • Massachusetts: estates larger than $1 million
  • Minnesota: estates larger than $3 million
  • New York: estates larger than $5.85 million
  • Oregon: estates larger than $1 million
  • Rhode Island: estates larger than $1,579,922
  • Vermont: estates larger than $4.25 million
  • Washington: estates larger than $2,193,000
  • What Is the Estate Tax Deduction?

    The federal estate tax deduction helps ensure assets within an estate are not taxed twice by the federal government. The deduction relates to times when the estate has actual income coming in.

    For example, someone might have been in the act of selling personal property, such as a home, when they passed away. The income from that sale might come into the estate after the person dies. That income is now called Income in Respect of Decedent, or IRD.

    Estates must pay an income tax on IRD. However, you would also pay estate tax on the value of the IRD if the estate was above federal threshold. The estate tax deduction lets you deduct the amount you already paid in estate taxes from IRD income taxes owed so you aren't paying twice.

    How Do I Calculate My Estate Tax Deduction?

    Typically, your estate tax deduction is calculated when you file the final income tax related to IRD income. It's a good idea to work with a CPA or other tax professional if you have an estate big enough for this type of tax requirement and deduction, as the issues can become complex.

    Other Deductions That Can Reduce Your Estate Tax

    The estate tax deduction is not the only way you can potentially reduce your federal estate tax burden. Here are two other deductions to consider.

    1. Unlimited Marital Deduction

    Estate assets that transfer from spouse to spouse qualify for an unlimited deduction. That simply means that you can transfer as much value as you want to a spouse after your death without paying any federal income tax.

    2. Charitable Deduction

    In some cases, amounts that estates give to charities may be deducted from the total value of the state for the purposes of estate tax designation. The deduction amount is limited and depends on what type of charity you donate to.

    How Do I File My Estate Tax Return?

    When estates are past the threshold that requires filing a federal estate tax return, there's usually a lot of money on the line. Because of that, most people typically consult with a tax attorney or other professional to file their estate tax return. But you can also file your form online or download the necessary form 706 and supplemental forms from the Internal Revenue Service.

    Understanding estate taxes can be complex, and it's important to understand how your estate planning, or lack thereof, could impact your family after your death so you can make the best decisions for your situation.

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Jacob Hamilton

GM CreditRepair.com

With his master's degree from the University of Phoenix, Jacob has been working as the General Manager for CreditRepair.com for 2 years. Jacob is passionate about consumer finances and doing everything he can to make credit repair accessible....

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