Should be you concerned about a federal inheritance tax as part of your estate plan?
To answer that, you'll need to understand the Federal Estate and Gift Tax, including the exemptions and the tax rate.
What Is an Inheritance Tax?
Most people think of an inheritance tax as being any tax that is levied on an estate of a deceased person. There are two types of taxes in this category.
- Inheritance Tax. This tax is charged to a person who receives an inheritance. The person who receives the inheritance is responsible for filing the tax return to report what was received.
- Estate Tax. The deceased person's estate is charged this tax before anything is distributed to the beneficiaries. The personal representative or executor of the estate must file the tax return to report the total value of the estate.
Estate Taxes and the Federal Government
Technically speaking there is no federal inheritance tax, but there is a federal estate tax. The estate's personal representative or executor is responsible for filing the necessary documents with the Internal Revenue Service (IRS), and for paying any tax that might be owed.
The IRS also levies a tax on certain gifts that are made by a person while he or she is alive. Taxes on gifts made prior to death and on an inheritance are combined in the Federal Estate and Gift Tax.
Estate Taxes and State Government
Some states also levy estate taxes. The exemptions that apply and the estate or inheritance tax rate varies from state to state.
- Currently an estate tax is levied by Connecticut, Delaware, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New Jersey, New York, Oregon, Rhode Island, Vermont, Washington, and the District of Columbia.
- An inheritance tax is levied by Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania.
- And, yes, both types of taxes are levied by Maryland and New Jersey (although New Jersey will only have an inheritance tax for 2018).
Federal Estate and Gift Tax Exemptions
The Federal Estate and Gift Tax limits the amount one can transfer without incurring the tax. It does not matter to the IRS whether the wealth is transferred as a gift or upon death.
However, certain amounts are exempt from taxation. Congress is constantly playing with the amount of these exemptions, which often change from year to year. There is also political pressure to eliminate the tax altogether.
The basic way the Federal Estate and Gift Tax works is that all amounts of gifts and inheritance are added together, then certain exemptions are deducted from that total. If the result exceeds a certain dollar amount, the tax is levied on the excess.
Federal Gift Tax annual exemption.
There is currently an annual exemption of $14,000 per person. This means that you can give up to $14,000 each year to as many people as you wish. A husband and wife can give up to $28,000 per year per person. So, if you wished, you could give away everything you own this year without incurring any tax liability, PROVIDED that you don't give more than $14,000 to any one person ($28,000 if you are married). This exemption applies to each year, so you may give someone $14,000 this year, and $14,000 in each subsequent year, without incurring the tax. You can double that amount if you are married.
Federal Estate and Gift Tax lifetime exemption.
If you do give someone more than the allowed annual amount, that excess will be added to the value of your estate at the time of death to determine the amount subject to the combined Federal Estate and Gift Tax. However, a lifetime exemption, commonly called the unified credit, will be applied. For people who died in 2016, the unified credit is $5.45 million. For 2017, the unified credit is $5.49 million. Current law requires the amount of the exemption to be indexed for inflation each year.
There is also an unlimited exemption for transfers from one spouse to the other. You may also use your deceased spouse's unused exemption, but you must indicate an election to do so on your spouse's estate tax return (even if no tax is due from her estate).
Federal Estate and Gift Tax Rate
For 2017, the Federal Estate and Gift Tax Rate is 40%. This means that, if the total value of your estate at death, plus any gifts made in excess of the annual gift tax exemption, exceeds $5.49 million, the amount above $5.49 million will be subject to a 40% tax. As with the exemptions, there is always the possibility that Congress will change the tax rate for future years.
When to Consult an Estate Planning Expert
This article gives a basic explanation of the Federal Estate and Gift Tax. If you expect your estate to exceed the allowed exemptions, or to be subject to an inheritance tax, you should consult an estate and tax planning expert.