What You Should Know About Estate Taxes
1. What is the Estate Tax?
Commonly referred to as the death tax, the purpose of the estate tax is to prevent family dynasties from securing the lion’s share of our nation’s wealth. The estate tax is not a tax on wealth, but rather a tax on the transfer of wealth from a deceased person to heirs. Similarly, it should not be confused with an inheritance tax because the tax is paid by the deceased person’s estate before the heirs receive any inheritance.
The federal estate tax rate is 18 to 40%, with the maximum rate applicable to taxable transfers above $1,000,000. However, a transfer is not taxable to the extent it is exempt (see #2 below). Many states have their own version of the estate tax, although Arizona does not.
2. Who is exempt from the Estate Tax?
The federal estate tax is typically irrelevant to most people because of the “applicable estate tax exemption.” This exemption protects a specified amount from federal estate tax. It is commonly referred to as the “estate tax credit” or “exemption amount.”
For persons dying in 2023, up to $12.92 million may be transferred free of estate tax using the applicable estate tax exemption. The exemption is unified with the gift tax because the exemption amount is reduced by the total amount of taxable gifts made during the deceased person’s lifetime. Thus, lifetime gifts of $1 million would reduce the applicable estate tax exemption to $11.92 million. The exemption amount adjusts annually for inflation.
3. How is the taxable estate determined?
The taxable estate includes most everything the deceased person owned. Hard-to-value assets like businesses and real estate must be professionally appraised. Any proceeds from life insurance on the deceased person are included, assuming the deceased person had control of the policy. The good news is that there are many proven techniques to reduce the estate tax:
4. How does the Marital Deduction work?
Upon the death of a married spouse, no estate tax is due if the deceased spouse’s share of assets is transferred outright to the surviving spouse. A problem may occur later, however, when the surviving spouse dies. All of the couple’s assets, including appreciation, are potentially subject to estate tax with only the surviving spouse’s $11.58 million exemption available to help. In response, a traditional estate planning technique is to retain the deceased spouse’s share of assets in a Credit Shelter trust (aka Bypass trust). Although its assets are available to the surviving spouse if needed, they are exempt from the estate tax when the surviving spouse dies.
A major feature of the current law is the concept of “exemption portability.” This feature allows married couples to share their estate tax exemptions, making it simpler to shelter up to $25.84 million from estate taxes. For example, if Husband dies in 2023 with a $2 million estate, then Wife may have an $23.84 million exemption ($12.92M for Wife + $10.92M unused by Husband).
At first glance, the portability feature provides an attractive alternative to the traditional use of a Credit Shelter trust during the lifetime of the surviving spouse. In fact, it may be the best choice in some situations. However, a closer look may reveal valid reasons to continue with traditional Credit Shelter Trust planning rather than rely on portability of the unused exemption.
5. How permanent is the current law?
The estate tax laws are subject to the political winds of change. It is hard to predict what Congress may do as future Presidents come and go from office. There are regular discussions about changing the credit amount or repealing the estate tax altogether, but any action requires broad agreement in Congress. In today’s political climate, the chances of broad agreement about repealing the estate tax are slim. Most likely the estate tax is here to stay, with adjustments made to the credit amount and tax rates from time to time.
About the Author
Thomas J. Bouman provides legal counsel in the areas of estate planning, estate settlement, and asset protection. He brings a highly systematic approach to the practice of law, which is critically important when wading through the complex, and often bizarre, legal requirements associated with estate and trust law. Mr. Bouman is author of the Arizona Estate Administration Answer Book and a prominent member of Wealth Counsel, LLC, the nation’s premiere organization of estate planning attorneys.
Commonly referred to as the death tax, the purpose of the estate tax is to prevent family dynasties from securing the lion’s share of our nation’s wealth. The estate tax is not a tax on wealth, but rather a tax on the transfer of wealth from a deceased person to heirs. Similarly, it should not be confused with an inheritance tax because the tax is paid by the deceased person’s estate before the heirs receive any inheritance.
The federal estate tax rate is 18 to 40%, with the maximum rate applicable to taxable transfers above $1,000,000. However, a transfer is not taxable to the extent it is exempt (see #2 below). Many states have their own version of the estate tax, although Arizona does not.
2. Who is exempt from the Estate Tax?
The federal estate tax is typically irrelevant to most people because of the “applicable estate tax exemption.” This exemption protects a specified amount from federal estate tax. It is commonly referred to as the “estate tax credit” or “exemption amount.”
For persons dying in 2023, up to $12.92 million may be transferred free of estate tax using the applicable estate tax exemption. The exemption is unified with the gift tax because the exemption amount is reduced by the total amount of taxable gifts made during the deceased person’s lifetime. Thus, lifetime gifts of $1 million would reduce the applicable estate tax exemption to $11.92 million. The exemption amount adjusts annually for inflation.
3. How is the taxable estate determined?
The taxable estate includes most everything the deceased person owned. Hard-to-value assets like businesses and real estate must be professionally appraised. Any proceeds from life insurance on the deceased person are included, assuming the deceased person had control of the policy. The good news is that there are many proven techniques to reduce the estate tax:
- Marital Deduction. Assets distributed outright or in a qualified trust for a surviving spouse qualify for an unlimited deduction. However, such assets (plus appreciation) will be subject to estate tax when the surviving spouse dies.
- Charitable Deduction. Assets distributed to charity after your death may qualify for an unlimited deduction.
- Gifting Strategies. Various lifetime gifting strategies will reduce substantially what would otherwise be subject to estate tax.
- Discounting Strategies. Various types of assets will qualify for a valuation discount. For example, the fair market value of a 50% interest in a limited liability company (“LLC”) with a restrictive operating agreement is probably less than the actual value of 50% of the underlying assets in the entity.
4. How does the Marital Deduction work?
Upon the death of a married spouse, no estate tax is due if the deceased spouse’s share of assets is transferred outright to the surviving spouse. A problem may occur later, however, when the surviving spouse dies. All of the couple’s assets, including appreciation, are potentially subject to estate tax with only the surviving spouse’s $11.58 million exemption available to help. In response, a traditional estate planning technique is to retain the deceased spouse’s share of assets in a Credit Shelter trust (aka Bypass trust). Although its assets are available to the surviving spouse if needed, they are exempt from the estate tax when the surviving spouse dies.
A major feature of the current law is the concept of “exemption portability.” This feature allows married couples to share their estate tax exemptions, making it simpler to shelter up to $25.84 million from estate taxes. For example, if Husband dies in 2023 with a $2 million estate, then Wife may have an $23.84 million exemption ($12.92M for Wife + $10.92M unused by Husband).
At first glance, the portability feature provides an attractive alternative to the traditional use of a Credit Shelter trust during the lifetime of the surviving spouse. In fact, it may be the best choice in some situations. However, a closer look may reveal valid reasons to continue with traditional Credit Shelter Trust planning rather than rely on portability of the unused exemption.
5. How permanent is the current law?
The estate tax laws are subject to the political winds of change. It is hard to predict what Congress may do as future Presidents come and go from office. There are regular discussions about changing the credit amount or repealing the estate tax altogether, but any action requires broad agreement in Congress. In today’s political climate, the chances of broad agreement about repealing the estate tax are slim. Most likely the estate tax is here to stay, with adjustments made to the credit amount and tax rates from time to time.
About the Author
Thomas J. Bouman provides legal counsel in the areas of estate planning, estate settlement, and asset protection. He brings a highly systematic approach to the practice of law, which is critically important when wading through the complex, and often bizarre, legal requirements associated with estate and trust law. Mr. Bouman is author of the Arizona Estate Administration Answer Book and a prominent member of Wealth Counsel, LLC, the nation’s premiere organization of estate planning attorneys.