What Are Death Taxes?
Death taxes are taxes imposed by the federal and/or state government on someone’s estate upon their death. These taxes are levied on the beneficiary who receives the property in the deceased’s will or the estate which pays the tax before transferring the inherited property.1
Death taxes are also called death duties, estate tax, or inheritance tax.
Understanding Death Taxes
The death tax can be any tax that is imposed on the transfer of property after someone’s death.2 The term “death tax” gained popularity in 1990s and was used to describe estate and inheritance taxes by those who want the taxes repealed. With the estate tax, the deceased’s estate pays the tax before the assets are transferred to the beneficiary.2 With the inheritance tax, the person who inherits the assets pays.3
The estate tax, charged by the federal government and some state governments, is based on the value of property and assets at the time of the owner’s death. As of 2018, the federal estate tax is up to 40% of the inheritance amount.4 Twelve states impose a state estate tax separate from that of the federal government. These states are Connecticut, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Vermont, and Washington.5
The federal government does not impose an inheritance tax, but several states do—Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. However, in all of these states, property passing to a surviving spouse is exempt from inheritance taxes.5 Nebraska and Pennsylvania impose taxes on property passing to a child or grandchild in some instances.6 7
Most people end up not paying the death tax as it applies to only a few people. For instance, the 2018 federal tax law applies the estate tax to any amount above $10 million,8 which, when indexed for inflation, allows individuals to pass on $11.18 million ($22.36 million for couples), without paying a penny of tax.2 For example, assume an individual leaves $11.8 million (accounted for inflation) in non-exempt assets to his children. The amount above the federal level, that is, $11.8 million – $11.2 million = $1.02 million, will be subject to estate tax. Therefore, the estate will have a death tax liability of 40% x $1.02 million = $408,000. As long as the decedent’s estate is valued at less than the applicable exemption amount for the year of death, the estate won’t owe any federal estate taxes.
The unified tax credit has a set amount that an individual can gift during their lifetime before any death taxes or gift taxes apply. The tax credit unifies both the gift and estate taxes into one tax system which decreases the tax bill of the individual or estate, dollar to dollar. Since some people prefer to use the unified tax credits to save on estate taxes after their deaths, the unified tax credit may not be used for reducing gift taxes while still alive, and may instead be used on the inheritance amount bequeathed to beneficiaries after death.9
Another provision available to reduce death tax is the unlimited marital deduction, which allows an individual to transfer an unrestricted amount of assets to his or her spouse at any time, including at the death of the transferor, free from tax.10 The provision eliminates both the federal estate and gift tax on transfers of property between spouses, in effect treating them as one economic unit. The transfer to surviving spouses is made possible through an unlimited deduction from estate and gift tax that postpones the transfers taxes on the property inherited from each other until the second spouse’s death.11 In other words, the unlimited marital deduction allows married couples to delay the payment of estate taxes upon the death of the first spouse because after the surviving spouse dies, all assets in the estate over the applicable exclusion amount will be included in the survivor’s taxable estate unless the assets are used up or gifted during the surviving spouse’s lifetime.
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