If you are concerned about estate taxes and wondering how they apply to you, here are five important facts about federal estate taxes that you should know. The federal estate tax is a tax on all property that is transferred from someone who has died to their heirs. Luckily, there is a federal estate tax exemption that means only the wealthiest estates actually pay taxes. Here is what you need to know about estate taxes.
No. 1. Only about 2 of every 1,000 estates is required to pay estate taxes
According to the Joint Committee on Taxation, 99.8% of all Americans are not required to pay any estate taxes upon their death. That equates to only 2 out of every 1,000 Americans. The reason is the federal estate tax exemption, which is $5.45 million for each individual. Married couples can double that exemption. Put simply, only the amount of your estate that exceeds $5.45 million will be assessed an estate tax.
No. 2. The tax rate is around sixteen percent
For those very few estates that owe estate taxes each year, the tax rate, on average, is 16.6 percent according to some reports. Sixteen percent is far less than the maximum statutory rate of 40 percent. This is quite contrary to the misconception that estate taxes consume almost half of an estate’s value.
No. 3. Tax-saving strategies make it easy for some estates to avoid taxes
There are various tax-saving strategies that can be used to help estates avoid tax. For example, some estates use Grantor Retained Annuity Trusts (GRATs), which are designed to repay the estate the initial amount plus interest, usually over two years. If the investment increases in value any gain goes to an heir tax-free. Otherwise, the full amount goes back to the estate.
No. 4. Only a few family-owned farms and businesses owe estate taxes
According to most reports, roughly 20 small business and/or farm nationwide were required to pay estate tax in 2013. A small business or farm is one with more than half its value in a farm or business and valued at less than $5 million. Of those 20 estates, the tax rate averaged at roughly less than 5 percent of their value.
No. 5. The Largest estates typically include “unrealized” capital gains that were never taxed
Capital gains tax is owed on the appreciation of assets, such as real estate, stock, or an art collection, only when the owner “realizes” or actually receives the gain, which is usually when the asset is sold. Consequently, the increase in the value of an asset is never subject to income tax as long as the owner holds on to the asset. These unrealized capital gains account for a substantial portion of the assets held by large estates.
California Estate Tax has been eliminated
As of January 1, 2005, California no longer imposes a separate estate tax at the state level. Therefore, the only estate tax liability California residents need to be concerned with is on the federal level. Currently, there are 17 states who still impose estate tax on the state level: Connecticut, Delaware, District of Columbia, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New Jersey, New York, Oregon, Rhode Island, and Vermont. North Carolina and Ohio appealed their estate tax law as of January 1, 2013. Tennessee phased out its estate tax as of January 1, 2016.
More about the federal estate tax exemption
The federal estate tax exemption allows an estate with a value below the exemption amount to be passed on tax-free. As of 2017, the exemption amount is $5.45 million. The tax exemption is “portable,” meaning that the surviving spouse of a decedent can take advantage of any unused portion of their deceased spouse’s exemption. The unused portion of the exemption is then added to the surviving spouse’s own exemption. For example, if only $2,000,000 of the wife’s $5,450,000 exemption is used, then the surviving husband can elect to add the husband’s remaining $3,450,000 exemption to his exemption. This will allow him to pass on up to $8,900,000, tax-free.
Using the marital deduction
Married couples can give a gift of an unlimited amount to their spouse. The value of the property gifted to the surviving spouse is deducted from the deceased spouse’s estate. If all assets go to the surviving spouse, then no estate taxes are imposed based on the “marital deduction.” A married couple can essentially protect $10.9 million from federal estate and gift taxes. This is commonly referred to as the lifetime credit.
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