The Basics of Estate Tax

School of Saving and Investing

Estate taxes illustrated by a house sitting on coins in front of a digital graph.

Your estate includes all the assets you owned at the time of your passing – homes, jewelry, cars, investments. If the value of your estate is over the applicable threshold, it could be subject to federal, and in some cases, state tax. These taxes are called estate taxes, or colloquially, the “death tax.”

If you don’t plan properly for estate taxes, they can erode the inheritance you planned to leave to your heirs and make the probate process more difficult. But if you are prepared, you can mitigate the effects.

Who needs to be concerned about estate taxes?

Only about 0.2% of estates are subject to tax because there are exemptions for small and moderately sized estates. If you have assets above the estate tax exemption threshold, or your assets are projected to be near the threshold, it is wise to plan for the possibility of estate tax.

Federal Estate Tax Exemption

The Tax Cuts and Jobs Act more than doubled the estate tax exemption for years 2018 through 2025. Additionally, the exemption is indexed for inflation each year. With these factors, the 2023 estate tax threshold is $12,920,000 per individual. However, when the Tax Cuts and Jobs Act expires in 2025, the estate tax exemption will revert to the previous level of $5 million plus inflation adjustments.

Married people can pass any unused exemption to their spouse, effectively doubling the estate tax exemption. To illustrate this concept, consider a couple with total assets of $20 million who had not used any of their estate tax exemption during their lives. When one spouse died in 2019, their assets and unused estate tax exemption passed to their spouse. If that spouse died in 2023, their total estate tax exemption would be $25,840,000 and their heirs would not owe federal tax on the $20 million estate.

State Estate and Inheritance Tax Exemptions

In addition to federal estate taxes, twelve states and the District of Columbia impose state estate taxes. The applicable exemptions vary by state but can be significantly lower than the federal estate tax exemption. For example, Oregon charges tax for estates valued at $1 million or more.

Further, six states charge an inheritance tax in addition to or instead of an estate tax. While these two types of tax sound similar, they have very different results for your heirs. Estate tax is paid by the estate before assets are distributed to beneficiaries. On the other hand, inheritance tax is owed by beneficiaries who receive funds from an estate.

How much is the estate tax and who pays it?

The part of the estate that is subject to tax is typically taxed at a 40% rate for federal estate taxes. State estate tax rates vary but are typically lower than the federal rate.

The taxable portion of an estate is the fair market value of the estate on the date of death minus exemptions and deductions. The total value of the estate for this calculation includes jointly owned assets, gifts and gift tax within three years of death, and sometimes life insurance proceeds. Deductions include the estate tax exemption, mortgages, other forms of debt, charitable contributions, administration costs, and investment losses during the administration period.

The executor of your estate is typically responsible for calculating the value of the estate, filing the final tax return, and paying any taxes owed. In many cases, the executor will hire an accountant to complete these tasks. The cost of the accountant is often considered an “administration cost” which acts as a deduction from the total value of the estate.

The Intersection of Gift Tax and Estate Tax

If not for the gift tax, the simplest way to avoid estate tax would be to give away your assets before you die. However, the gift tax essentially charges high net worth individuals estate tax while they are living.

Each year, you can give up to $17,000 per person without owing gift tax. Married couples can give twice that amount. However, if you give more than $17,000 to a single person – $34,000 if you are married – you begin to use your estate tax exemption. Once you use all the estate tax exemption, you must pay tax on the gifts you give.

For example, if you and your spouse have three grandchildren, you could give each of them $30,000 per year to help with their living expenses without paying gift tax. On the other hand, if you gave each of them $40,000, you could owe tax on the $6,000 you gave each grandchild over the annual exclusion. If you had not used your estate tax exemption, the value of your gifts would not be taxable, but would reduce your estate tax exemption. If you had used all your estate tax exemption, the amount of your gifts over the annual exclusion would be subject to tax.

Planning for Estate Taxes

There are many strategies for minimizing estate taxes. Some of the most common include:

  • Using certain types of trusts which bypass your estate and allow you to move assets to your beneficiaries without estate tax.
  • Taking advantage of certain forms of life insurance which are not included in your gross estate.
  • Reducing the value of your estate by giving gifts each year, in amounts less than the annual gift tax exclusion.
  • Moving to a state that doesn’t have a state estate tax.

These strategies are often complex. Many of them require a vast knowledge of financial planning, tax planning, and estate law to execute properly. That’s why it is wise to partner with a wealth management firm that has an experienced team of tax, legal, and investment professionals.

Plan For Estate Tax with Meld Financial

The experienced team at Meld Financial can help you develop a comprehensive estate plan. This includes ensuring your assets pass as you intended, reducing work for your beneficiaries, and minimizing estate taxes.

Our unique wealth management plan, Financial Fingerprint™ is quick to assemble, easy to understand, and simple to modify as your circumstances change. It was developed through decades of effectively managing our clients’ wealth. With Financial Fingerprint™ you can balance the most important aspects of your financial life from saving for retirement to crafting a solid estate plan.

Contact us today to learn more and get started.

Trending Articles

Weekly Economic Update presented by Meld University
Weekly Economic Update

School of Financial Wellness

Stocks slumped. The FOMC held interest rates steady and updated projections. Existing home sales and home builder confidence fell.

Wealth managers are key to your investment strategy.
5 Characteristics of a Quality Wealth Manager

School of Financial Wellness

Looking for a quality wealth manager? We pulled together our list of the 5 most important qualities to consider during your search.

A desk with a calculator, glasses, money and 3 blocks with IRA, 401k and ROTH written on them. These are meant to represent a guide to the many different kinds of retirement plans.
Retirement Accounts: A Comprehensive Guide

School of Saving and Investing

There are so many different types of retirement accounts, it can be difficult to keep track. This handy guide makes it easy.

Why Meld Financial?

Meld Financial, Inc. is an independent wealth management firm located in Birmingham, AL.

We specialize in financial planning, investment management, employee benefits and executive benefits for individuals, families, trusts, foundations and institutions.

We provide independent and objective services melded with customer-driven financial goals.

Mark McGarvey - Founder - Meld Financial

“We will always recommend the same course of action we would choose for ourselves, given the same circumstances.”

-Mark McGarvey, Founder