Estates and Taxes

Like the end of life, taxes are also inevitable when your estate is passed on. There are five ways your estate may be taxed after you die, three of which will be paid by your beneficiaries and two by your estate.

The laws governing estate and gift taxes are quite complex, change frequently, and do not apply to all of your assets. 

In 13 states you will be subject to both federal and state estate tax. There is variability from state to state in the estate value limit and which assets are taxable. States also differ about whether domestic partners are defined as spouses.

Other states have inheritance tax and one state (Maryland) has both. Your beneficiaries may also be subject to income taxes and capital gains taxes if they make a profit from your estate. Because of all this, you may require professional help to sort things out, especially if your estate is over the federal estate tax limit of $11,580,000 or in some cases your state’s estate tax limit, which can be as low as $1 million.

Gift Tax

A gift is any transfer, either directly or indirectly, to another individual where the donor is not compensated for the full value of the transferred item. There are factors that determine whether something is or is not a gift.

You make a gift if you:

  • Give property (including money and stocks) or the use of or income from property without expecting to receive something of at least equal value to the fair market value in return;
  • Pay for or give money for someone else’s honeymoon, vacations, cars, etc.; 
  • Give someone money for tuition and/or medical bills, as opposed to paying the bills directly;
  • Give an interest-free or reduced-interest loan to a family member or friend that they do not repay in full;
  • Have a joint account with someone other than your spouse and allow them to take out money for their own use; and/or
  • Add money to a child’s or other person’s irrevocable trust.

You may be making a gift if you:

  • Sell something at less than its full value; and/or
  • Give an interest-free loan or a loan for an interest rate lower than the applicable federal rate (the minimum interest rate that the Internal Revenue Service allows for private loans) to a family member or friend even if they pay you back.

It may not be considered a gift to someone if you pay their school directly for tuition or the hospital directly for medical bills.

Gifts to tax-exempt organizations are excluded. This could include: 

  • Certain charities;
  • Political organizations;
  • Social welfare organization or civic league;
  • Labor, agricultural, or horticultural organization; and/or
  • A business association, such as a chamber of commerce.

Giving away estate assets either before or after your death are considered gifts and can result in taxes for you or your beneficiaries. When you give something away to another person while you are alive you may be assessed gift taxes.

  • Gift taxes are the only ones that will be assessed on your estate while you are alive.
  • What’s confusing is that they are tied in to the federal estate tax exemption and not paid until after you die and only if the total value of your life-time gifts plus the current value of your estate is more than the limit for that year ($11,700,000 in 2021).
  • The tax rates are graduated for the amount over the limit your estate is and range from 18%-40%.

You can use gifts while you are alive to reduce your gross or taxable estate. In addition to money, gifts can include stocks, bonds, cars, or other assets.You will need to know about the federal allowances to avoid these gift taxes. This also applies in most states with estate taxes.

You are limited in the amount of your assets you can give away as non-taxable gifts during your lifetime, or since 1972 if you are older, before the federal government taxes the gifts

Married couples can gift up to $30,000 per person each year, if you both agree (Internal Revenue Code § 2513).

These limits do not apply to gifts to spouses if they are citizens of the USA. If your spouse is a noncitizen, the 2020 limit is $157,000, and the 2021 limit is $159,000. (Internal Revenue Code § 2523(a))

Any yearly gift that is below the per person limit for that year will reduce the value of your estate without affecting the federal estate tax limit..

  • Any gift over this amount will affect the federal estate tax limit and lower the non-taxable limit to $11,700,000 minus the amount that exceeded the limit the year the gift was given.
  • This is cumulative for each individual gift over limit per person per year.

If you give a gift in 2021 and:

  • Don’t exceed this limit, you can use these gifts to reduce the value of your estate and reduce federal estate taxes or eliminate it if you can get your estate value less than the 2021 federal estate tax limit of$11.7 million; or
  • Exceed the limit, it will reduce the value of your estate but will also reduce the tax-free limit to below $11,70,000. If your 2019 gift exceeds $15,000 by $100,000, you will have to pay estate tax if your estate is $11,600,000 at your death.

This can be used to reduce your estate below your state’s estate tax limit.

Any gifts exceeding the annual per person gift amount for that year will have a gift tax for the amount the gift exceeds that limit. Instead of being collected at that time, the amount is deducted from the limit that applied to that year, therefore lowering the limit before taxes will be assessed.

  • If you gave someone $50,000 in 2013, when the annual gift exclusion was $14,000, $36,000 will be deducted from the estate when it is transferred, instead of you being assessed a tax at that time.
  • If it is transferred in 2020, your estate only needs to be $11.544 million before it becomes taxed.
  • This will apply to your state limit if your state has their own estate tax.

Although you do not actually pay a gift tax, you must file a gift tax return (IRS Form 709) by April 15th following the year in which the gift exceeding the 2020-2021 limit of $15,000 was given.

A special rule allows you to spread a one-time gift across five years’ worth of gift tax returns to preserve your lifetime gift exclusion.

The person receiving the gift usually does not need to report the gift, but the money needs to be included in their yearly tax return.

Estate Tax

An estate tax is a tax on the right to transfer property above a designated federal limit to anyone but your spouse or minor children when you die. It is commonly referred to as a Death Tax.

All property left or gifted to your surviving spouse is inherited free of estate tax (I.R.C. § 2056(a)).

For federal tax purposes, the definition of a spouse includes any person lawfully married, including same-sex marriage (Obergefell v. Hodges)

The federal estate tax exemption does not apply if your spouse is not a citizen of the United States.

The estate tax exemption limit will apply for property left or gifted to loved ones who are not eligible for the spousal exclusion, such as:

  • Noncitizen spouses;
  • Couples not considered spouses (i.e. married) in their state; and/or
  • People who have entered domestic partnerships, civil unions, or other similar formal relationships recognized in their state, but not considered married.

The 2021 federal limit is increased to $11.7million, and will increase with inflation until December 2025 if the Tax Cuts and Jobs Act of 2017 remains in effect. Since less than 0.1% of all estates exceed this, most of this information only applies to wealthy families.

The value of your estate includes the amount in your will plus the value of any individual and/or family trusts.

You are only taxed on the amount over the limit.

For example, if your taxable estate is $12 million, only $600,000 will be taxed.

The federal limit only applies to your gross estate, or taxable estate if you qualify for certain deductions.

If the estate has been held up in court for a while, the limit will be based on the year you died.

States with their own estate tax have different limits, ranging from $1,000,000 to $5,740,000.

  • This makes trusts useful for more people in these states, not just the 0.1%ers.
  • This will be especially helpful in states that tax an entire estate if it exceeds the limit, not just the amount over the limit, like the federal tax.

Your Gross Estate is calculated based on an accounting of everything you own by yourself, are the trustee of, or have certain interests in at the time of your death.

  • This property may include cash, savings, securities, real estate, insurance, trusts, annuities, business interests, vehicles, jewelry, collectables and other assets as found on IRS Form 706 (PDF).
  • The worth of each asset is determined by the fair market value of these items, which may not be what you paid for them or what their values were when you inherited them (IRC §1014).

Your Taxable Estate is usually less than your gross estate due to deductions and allowed reductions in value.

  • You can deduct certain expenses and gifts such as mortgages and other debts, funeral expenses, estate administration, legal expenses, property that passes to surviving spouses, estate taxes paid to states, and gifts to qualified charities.
  • Your estate may qualify for the reduction of the value of certain operating business interests or farms. 

Calculation of Federal Estate Tax

While all estates are subject to federal estate tax, 13 states and the District of Columbia also have a state estate tax. All have lower estate tax thresholds than the federal government.

  • Like the federal estate tax, these are paid from the estates assets.
  • Most states use a graduated scale based on the amount the estate exceeds the limit to assess an estate’s tax liability
  • Many states increase the limit for inflation, while Connecticut will increase the limit rapidly until it equals the federal limit by 2023.

Estate Tax Limit and Rates by State

State

2021Taxable Estate Exclusion Amount

Tax Rates

Connecticut

$7.1 million

10%-12%

District of Columbia

$4 million

Up to 16%

Hawaii

$5.49 million

Up to 20%

Illinois

$4 million

Up to 16%

Maine

$5.9 million

8%-12%

Maryland

$5 million

0.8%-16% 

Massachusetts

$1 million

5.6%-16%

Minnesota

$3 milion

13%-16%

New York

$5.85 million

3.06%-16%

Oregon

$1 million

10%-16%

Rhode Island

$1.579,922

Up to 16%

Vermont

$5 million

Up to 16%

Washington

$2.193 million

10%-20%

 

If you live in one of these states your state estate tax payments are subtracted from the value of your taxable estate before you calculate your federal estate taxes.

What Happens If I’m Over the Limit

If you’ve tried to get your estate value down but the taxable amount still exceeds $11.58 million, you are in the minority. In 2019, only 0.1% of estates were at risk.

There are a number of steps taken if your estate is over the limit.

  • Your executor will need to file a federal estate tax return within nine months of your death. A six month extension is available if requested prior to the due date and the estimated correct amount of tax is paid before the due date.
  • Federal estate taxes will be calculated based on the amount your estate exceeds $11.58 million, not the total estate.
  • If your estate has exceeded the gift limit during your lifetime, the excess amount will be added to the taxable amount which would have the same effect as lowering the estate tax limit by that amount.

The taxes will be paid with assets from your estate, not by your beneficiaries.

The estate assets are typically adjusted each year for inflation.

If your estate is over the limit, this table can give you a ballpark figure of the estate tax. Each Interval dollar amount of your estate up to $1 million dollars is taxed at a different rate, but the maximum is 40%.

Reducing Estate Tax

With knowledge about taxable and non-taxable assets there are ways to reduce your taxable estate, aside from leaving everything to your spouse. Some are more practical than others.

  • Spend assets on vacations, entertainment, expensive dinners, and other intangible experiences. Be sure not to overspend before you pass on.
  • Spread them around to your family or friends. See Gift Tax.
  • Shield them in a trust or by a joint ownership with your spouse.
    • Well crafted AB, credit shelter, or bypass trusts could provide a way to legally shelter some of your assets from federal estate tax.
    • You will need to check the regulations in your state concerning what assets are protected from state and inheritance taxes.
  • Increase the federal tax limit for your estate when your spouse dies and passes it on.
    • If your spouse files IRS form 706 after your death, they may be able to add your unused exemption, based on the amount remaining from the limit the year you died, to the exemption limit for the year that they die.
      • For example, if you died in 2016 when the limit was $5,450,000 and you did not exceed this life-time gift limit, and your spouse died in 2019, they could have passed on an estate of $16.85 million before any estate tax will be collected.
  • Other ways to get your estate under the limit without worrying about the gift tax include:
    • Gifts to a political organization;
    • Charitable gifts; and/or
    • Moving to a more favorable tax environment. This is the least practical option, but if you are ready for a change, you can consider moving to the many states that don’t have an estate or inheritance tax.

Inheritance Tax

As opposed to an estate tax which is a tax on your estate for the right to bequeath your assets, an inheritance tax is paid by your beneficiaries for the right to inherit your assets. Your spouse is exempt from inheritance taxes as are certain close relatives in four of the six states that have them.

Your beneficiaries pay inheritance tax based on the state you lived in, not the one they live in.

  • They would be taxed if you lived in one of the six states with inheritance tax, even if they live in a different state that does not have them. The tax is paid to the state you lived in.
  • They would not be taxed if you lived in one of the 44 states without inheritance tax, even if they live in a different state that has them. However, they would be taxed if the asset they received is located in their state.

Inheritance taxes can be assessed on property transferred via a will, intestate succession, trust, or a deed, depending on your state (and/or county) statutes. The IRS does not consider inheritance taxable income.

The federal government does not have an inheritance tax, but in 2020 Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania collect inheritance tax. Only Maryland has both estate and inheritance taxes. 

Spouses are not assessed inheritance taxes in any of these states. In addition:

  • New Jersey exempts domestic partners;
  • Iowa, Maryland, and New Jersey exempt parents and children/grandchildren; and
  • Kentucky exempts parents, children/grandchildren, siblings, and half-siblings.

Unlike Estate Tax, inheritance taxes are paid by the beneficiary.

Each state has a threshold inheritance value below which no inheritance tax is collected.

  • The limit depends on an heir’s relationship with you. The closer the relationship, the higher the limit.
  • Only inheritance above the state limit is taxed

The inheritance tax amount is a percentage of the total value of the inherited property rates and they will vary according to the beneficiary’s relationship to you.

  • More distant relatives or heirs who aren’t related to you usually have the highest inheritance tax rates.
  • In some states the tax rate increases with increasing gift amounts.

Go to State-specific Estate Planning Information for details about your state.

Aside from spending your money while you are alive to reduce the inheritance, you can reduce the amount of inheritance tax by giving assets away while you are alive.

Income Tax

Unlike earned income, inheritance is not considered taxable income and does not need to be claimed on your state or federal income tax return. While the Inheritance itself is not taxed as income by the Internal Revenue Service, there are three circumstances where income tax will be due. 

  1. Any taxable income that was not reported as income before your death must be reported as income by the beneficiary, whether an heir or the estate.
  • These assets include employee compensation, bonuses, partnership income, interest, dividends, gain on sale of property occurring prior to death when funds are paid after death, crops, livestock, installment obligations, and royalties.
  • Although your beneficiary pays the income tax, the funds essentially come from the estate. The payment can be looked at as money that would not have been there if you had reported it.
  1. Any estate account created after your death that earns interest before the estate is settled will be taxed as income. The money comes directly from the estate, not the beneficiary.
  2. Any income from inherited assets can be taxed.
  • Retirement accounts such as 401(k)s and IRAs are taxed when your beneficiary withdraws from the accounts. 
    • Any income or interest generated from property or assets is usually taxable after your beneficiary takes possession of them, such as stocks, bonds, or annuities and tangible assets like cars, boats, and real estate.
  • The income from any asset that is sold within the first year after it is inherited is taxed according to the seller’s tax bracket. This is the case at the state level as well.

Capital Gains Tax

A capital gain happens when an asset is worth more than you paid for it. The amount you paid for the asset is called the basis. The gain is unrealized before the asset is sold or transferred, and becomes realized and taxable when the asset is sold at a higher price than what you paid. While the topic of capital gains and capital gains tax is complex, this section will focus on those aspects associated with inheritance.

While capital gains taxes are not assessed when your beneficiaries inherit assets,, they may be when they sell assets they have received. Only the capital gain amount is taxed, not the total value of the asset. States may have their own capital gains tax regulations.

  • Capital assets can include property such as your home and vehicles, common stocks and bonds, mutual funds, and collectables.
  • Not all assets are subject to capital gains, such as other portions of business inventory and non-physical items such as patents, formulas, and compositions. 

Basis for Capital Gains at the Time of Inheritance

While capital gain is the difference between what you paid for the asset (the basis) and what it is worth when it is isold or gifted, this does not apply when assets are inherited. Therefore, capital gains taxes are not assessed at the time of inheritance.

The basis of any inherited asset is the fair market value at the time or inheritance, whether it is more or less than the original purchase price.  

  • In most cases this will be a major benefit since the basis of most assets will be stepped-up, i.e. worth more than when acquired.
    • If the asset is a joint tenancy property, only the deceased co-owners basis is stepped-up; the surviving owners half of the asset is not.
    • If you have an estate worth more than the estate tax limit, there may be an option to set the basis to the value six months after it is inherited. To do this you must make an election on IRS Form 706 within one year of the due date of the federal estate tax return.
  • This is a disadvantage if the basis is less than the purchase price (stepped-down) since your beneficiaries inheritance would be less.

Capital Gains Tax After Sale of the Asset

Capital gain happens and capital gains taxes are due when your beneficiary sells their inherited assets above the fair market value at the time it was inherited.

  • A stepped-up basis results in your beneficiary paying less capital gains tax if they sell the asset for more than the fair market value.
  • Capital gains tax would still be owed if the basis was stepped-down and the asset is sold at more than the fair market value.

Capital loss happens if the opposite is true. No taxes are due and, except for personal property, you can deduct the loss from your income tax.

The capital gain or loss should be recorded on your income tax return for the year the inherited asset was sold.

Assets sold after being inherited following your death can generate either a long-term or short-term capital gain, depending on when the property is sold.

A short-term capital gain applies to the sale of an asset owned for up to one year.

  • If sold immediately at the fair market value, which would be the same as the basis, there would be no capital gains or tax.
  • If sold immediately for more than the fair market value, which would be more than the basis, a capital gains tax would be assessed on the amount over that value.
    • The basis remains the same, even if the fair market value changes over time, and a capital gains tax is due if the selling price is above the basis.
  • Short-term capital gains are taxed as though they were income at your beneficiaries income tax rate, i.e. their tax bracket.

A long-term capital gain is the profit from the sale of an asset held for more than a year.

  • Gains from the sale of inherited stock are an exception; they are classified as long-term capital gains even if they are sold shortly after inheriting them.
  • They are generally lower than short-term capital gains tax rates and are based on income and filing status.

2020 Short Term Capital Gains Tax Rates


Tax Rate

Income

Single Filer

Married Filing Jointly

Married Filing Separately

Head of Household

10%

Up to $9,875

Up to $19,750

Up to $9,875

Up to $14,100

12%

$9,876 – $40,125

$19,751 – $80,250

$9,876 – $40,125

$14,101 – $53,700

22%

$40,126 – $85,525

$80,251 – $171,050

$40,126 – $85,525

$53,701 – $85,500

24%

$85,526 – $163,300

$171,051 – $326,600

$85,526 – $163,300

$85,501 – $163,300

32%

$163,301 – $207,350

$326,601 – $414,700

$163,301 – $207,350

$163,301 – $207,350

35%

$207,351 – $518,400

$414,701 – $622,050

$207,351 – $311,025

$207,351 – $518,400

37%

More than $518,400

More than $622,050

More than $311,025

More than $518,400

2021 Short Term Capital Gains Tax Rates


Tax Rate

Income

Single Filer

Married Filing Jointly

Married Filing Separately

Head of Household

10%

Up to $9,850

Up to $19,900

Up to $9,850

Up to $14,200

12%

$9,851 – $40,525

$19,901 – $81,050

$9,850 – $40,525

$14,201 – $54,200

22%

$40,526 – $86,375

$81,051 – $172,750

$40,526 – $86,375

$54,201 – $86,350

24%

$86,376 – $164,925

$172,751 – $329,850

$86,376 – $164,925

$86,351 – $164,900

32%

$164,926 – $209,425

$329,851 – $418,850

$164,926 – $209,425

$164,901 – $209,400

35%

$209,426 – $523,600

$418,851 – $628,300

$209,426 – $314,150

$209,401 – $523,600

37%

More than $523,600

More than $628,300

More than $314,150

More than $523,600

2020 Long Term Capital Gains Tax Rates

Tax Rate

Income

Single Filer

Married Filing Jointly

Married Filing Separately

Head of Household

0%

Up to $40,000

Up to $80,000

Up to $40,000

Up to $53,000

15%

$40,000 – $441,450

$80,001 – $496,600

$40,001 – $248,300

$53,001 – $469,050

20%

More than $441,450

More than $496,600

More than $248,300

More than $469,050

2021 Long Term Capital Gains Tax Rates

Tax Rate

Income

Single Filer

Married Filing Jointly

Married Filing Separately

Head of Household

0%

Up to $40,400

Up to $80,800

Up to $40,400

Up to $54,100

15%

$40,401 – $445,850

$80,801 – $501,600

$40,401 – $250,800

$54,101 – $473.750

20%

More than $445,850

More than $501,600

More than $250,800

More than $473,750

2020 and 2021 3.8% Net Investment Income Tax

Filing Status

Adjusted Gross Income Threshold Amount

Single

$200,000

Married Filing Jointly

$250,000

Married Filing Separately

$125,000

Head of Household

$200,000

Qualifying Widower with Dependent Child

$250,000

Generation-skipping Tax

The generation-skipping tax (GST), also called the generation-skipping transfer tax, is an estate tax. It applies to the transfer of assets either through a will or trust directly to a beneficiary other than your spouse that is 37 ½ years or more younger than you. This includes other family members and unrelated individuals.

It was created as a way to prevent you from avoiding estate tax by leaving some or all your assets directly to your grandchildren.

  • The GST tax will be assessed when you transfer money or property directly to your grandchildren without first leaving it to their parents. Like the estate tax, gifts of $15,000 per person per year are exempt.
  • It does not apply to transfers that have already been taxed when left to a previous generation, such as your grandchildren if their parents died before them (IRC Section 2651(e)). This is because your grandchildren effectively move up into their parents’ position and the gift is no longer skipping a generation.

Skipping or bypassing your children’s generation avoids your inheritance being subject to estate taxes when it moves from you to your children and then again from your children to your grandchildren.

The federal generation-skipping transfer tax will be assessed if the available inheritance is over your unused 2021 $11,700,000 tax exemption.

  • For example, if you have already transferred $10,000,000 of your estate, the remaining federal generation-skipping transfer tax credit would be $1,700,000. 
  • The transfer tax would only be levied on any amount over this amount.

Unlike the estate tax, which is a graduated taxation rate from 18% to 40%, depending on the amount over the limit, the generation-skipping tax is 40% of the entire amount.

In this example, if you left your grandchild $2,800,000, the estate would be over the tax credit by $1,100,000 ($2,800,000 minus $1,700,000) and the transfer tax would be $440,000 

($1,100,000 times 0.4).

You may be able to reduce gift, estate, and generation-skipping taxes by creating a Dynasty Trust.

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