Sometimes after the death of a loved one, we are left to deal with grief, funeral planning, and an estate. In some cases, we inherit assets from a deceased loved one. Unfortunately, not much in this life comes for free, and even the things we inherit can cost us. In this article, we will take a closer look at estate and inheritance taxes, including who is affected by them and how they work.
What Are Estate Taxes?
Estate taxes are federal taxes levied on the entire taxable estate of a deceased individual. The tax is calculated based on the asset’s current market value. The IRS exempts estates worth less than $12.06 million in 2022 and $12.92 million in 2023. The amounts are per person. Estates worth more than these amounts are taxed according to the following rates:
- 18% tax rate: $0 to $10,000
- 20% tax rate: $10,001 to $20,000
- 22% tax rate: $20,001 to $40,000
- 24% tax rate: $40,001 to $60,000
- 26% tax rate: $60,001 to $80,000
- 28% tax rate: $80,001 to $100,000
- 30% tax rate: $100,001 to $150,000
- 32% tax rate: $150,001 to $250,000
- 34% tax rate: $250,001 to $500,000
- 37% tax rate: $500,001 to $7500,000
- 39% tax rate: $750,001 to $1,000,000
- 40% tax rate: $1,000,001 and up
Some states impose their own estate taxes, but in general, your estate tax bill is subtracted from the value of your taxable estate before you calculate what you might owe the IRS. The states that impose an estate tax are Connecticut, District of Columbia, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Vermont, and Washington.
Federal and state taxes are paid from the assets of the estate before they can be distributed to beneficiaries. Typically, the executor of the estate will ensure all taxes are paid from the estate, confirm there are no other liabilities needed to be paid, and then distribute the remaining assets.
What Are Inheritance Taxes?
Inheritance taxes are state taxes that are levied on the assets of a deceased individual. These taxes are typically paid by the heirs or beneficiaries of the estate, and the amount owed is calculated based on the total value of the estate. The assets can be anything from money to stocks to property. Currently, six states impose an inheritance tax:
- Iowa: 0% – 15%
- Kentucky: 0% – 16%
- Maryland: 0% – 10%
- Nebraska: 0% – 18%
- New Jersey: 0% – 16%
- Pennsylvania: 0% – 15%
Iowa is preparing to eliminate its inheritance tax for deaths on or after January 1, 2025. The tax rate you pay is typically determined by your relationship to the decedent. Surviving spouses are almost always exempt from this tax, and in some states, so are sons, daughters, and parents of the deceased. Usually, you will pay a higher rate if you had no familial relationship to the decedent.
Inheritance taxes come into effect after the estate has been divided and distributed to the appropriate beneficiaries. Typically, each state will have their own exemption rules, meaning that the assets inherited are taxed after they reach a certain value. For example, if your state imposes a 5% tax on inheritances larger than $3 million, and you inherited $5 million in assets, you will pay tax on $2 million.
How Can I Reduce Estate and Inheritance Taxes?
We know taxes are the furthest thing from your mind when grieving the death of a loved one. Alternatively, preparing a will should not have to result in worry over your loved ones paying taxes once you’re gone. If you are planning to leave behind assets for your loved ones after death, you can reduce estate taxes using a few methods. You can pay for educational or medical expenses from your estate and the payments will be exempt from taxes as long as the funds go directly to the provider. Also, setting up an irrevocable trust or life insurance trust (ILIT) can help ensure that assets are not used to pay taxes. A team of expert tax professionals can help. Contact us for a free, no-obligation tax consultation today.