Death and taxes. There aren’t too many more unappealing combos. Dentist and root canal? Nope. Skunk and burning tires? Maybe. But those still don’t come close to the dynamic duo of depressing things: death and taxes. Unless, of course, you combine the duo into a hideous monster called a death tax. (Cue the horror scream.)
A death tax is actually another name for an estate tax. It’s a federal or state tax on a person’s estate after they die. Score one for the politicians. You can’t complain about taxes if you’re dead, right?
But in all seriousness, the federal estate tax isn’t as scary as it sounds. The death tax has lost its sting because very few people have to pay it.
But you might be subject to state estate taxes (that’s fun to say), and we’ll get to that in a minute. So, how do estate taxes work? Let’s take a look.
What Is the Federal Estate Tax?
The federal estate tax is a tax based on the total value of your estate. This includes cash, property, investments and other assets.
Taxes shouldn’t be this complicated. Connect with a RamseyTrusted tax advisor.
When you die (and hopefully it’s sometime when flying cars are actually a thing), estate taxes are paid before any of your stuff is given to your heirs. Okay, time out. Before we go any further, this is just a friendly reminder to get a will if you don’t have one. Because every adult needs a will to make sure their family and their stuff are taken care of the way they want when they die.
Now, assuming you have a will, your estate must go through a legal process called probate, which includes figuring out the value of your estate and making sure taxes and other debts are paid before your heirs get paid.
What Is the Estate Tax Exemption?
So, here’s the good news: Estates valued up to $12.06 million for an individual or $24.12 million for a married couple are exempt from taxes.1 That’s huge. Whether you’re expecting to receive an inheritance or planning to leave one to your loved ones, let’s be realistic—it’s probably not going to be eight figures. The vast majority of estates are not subject to the federal death tax. A tax-free inheritance is a wonderful gift for you and your heirs.
Federal Estate Tax Rates for 2022
Now, if you’ve done really well for yourself—and we’re talking well with a bunch of zeroes at the end—and your estate exceeds the federal thresholds, brace yourself. Estate tax rates range from 18% to 40%.
The one ray of hope is that you only pay taxes on amounts above the $12.06 or $24.12 million threshold. The estate tax is also progressive. That means as the taxable amount increases, the tax rate gradually ticks up to a max of 40%.
2022 Federal Estate Tax Rates2
Here’s a quick example. Let’s say you’re single, and your estate is valued at $12.08 million. When you die, $12.06 million will be exempt from taxes. Of the remaining $20,000, $10,000 will be taxed at 18%, and $10,000 will be taxed at 20% for a total tax bill of $3,800.
Take a look at the chart one more time. Notice that those percentages jump up pretty quickly. If you have a giant estate that easily tops the $12.06 million or $24.12 million thresholds, you’ll find yourself in the 40% bracket faster than you can spell beneficiary.
Who Has to Pay Estate Taxes
Ever heard the expression, “Dead men tell no tales”? Maybe in a pirate movie? Well, dead men (or women) don’t pay taxes either. The executor of the estate is responsible for making sure debts and taxes are paid and inheritances are handed out. So, technically, estates pay estate taxes.
Surviving spouses also do not have to pay estate taxes. Estates pass to spouses tax-free because of the IRS unlimited marital deduction. However, when the surviving spouse dies, the estate will be subject to the $24.12 threshold for couples. That’s right, widows and widowers keep the higher exemption for couples.
States With Estate Taxes
The federal estate tax has a huge exemption, but 12 states and the District of Columbia have estate taxes with much lower exemption thresholds than the federal limit. The states are:
- New York
- Rhode Island
Oregon and Massachusetts assess taxes on estates valued at $1 million or more, but the average threshold among the states is about $4 million. Tax rates range from 0.8% to 20%.4
The Difference Between Estate Taxes and Inheritance Taxes
You might have heard the terms estate tax and inheritance tax used interchangeably. But they are, in fact, two different types of taxes. Estate taxes are paid by—you guessed it—an estate! Inheritance taxes are paid by heirs (i.e., the people getting the inheritance).
Only six states have an inheritance tax: Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania. If your loved one lived in one of these states, you might be on the hook for the inheritance tax. We say might because spouses, parents and children are exempt from paying inheritance taxes in Iowa, Kentucky, Maryland and New Jersey.5, 6, 7, 8 In Nebraska, only spouses are fully exempt, and Pennsylvania exempts spouses and minor children.9, 10
Inheritance tax rates range from 1% to 18% depending on your relation to the deceased and the size of the inheritance.
How to Plan for Estate Taxes
A great way to avoid estate taxes is to lower the value of your estate before you die. You can do this by giving tax-free gifts to future heirs. Wouldn’t it feel good to bless some people now rather than when you’re dead and gone?
The gift tax exclusion for 2022 is $16,000 per recipient per year.11 That means if you had the money, you could whip out your checkbook and write $16,000 tax-free checks to your mom, your brother, your kids, and your new best friends (you’ll have lots of “friends” if you start giving away tax-free money).
If you want to give a tax-free gift larger than $16,000, you can take advantage of the lifetime gift tax exclusion. This allows you to use part of your estate tax exclusion ($12.06 million for singles or $24.12 for couples) before you die.
For instance, say you and your spouse want to give your daughter $516,000 to buy a house. The first $16,000 would be tax-free due to the annual gift tax exemption. For the remaining $500,000 to be tax-free, you’d need to subtract it from your estate tax exclusion. That means when you and your spouse die, about $23.6 million ($24.12 million - $500,000) will be exempt from estate taxes. Yep, most of us will never come close to exceeding the estate tax exemption.
Another way to avoid estate taxes is to create an irrevocable trust. But this option is only for a tiny percentage of people who have huge estates. Trusts get complicated, but the basic idea is this: When you put your assets in an irrevocable trust, you no longer own them. So that property can't be taxed when you die because it’s technically owned by the trust.
Changes to the Estate Tax
The 2017 Tax Cuts and Jobs Act (TCJA) doubled the federal estate tax exclusion. (Yay for tax cuts!) But the higher exclusion is set to expire in 2025 and return to about $5.5 million for individuals (womp womp).12 And beware: A proposed law in the Senate is seeking to lower the exclusion to $3.5 million before 2025.13
If the estate tax exclusion is lowered, a lot more people could find themselves facing federal estate taxes. But if you use the higher exclusion now, you won’t be penalized when or if it’s cut.
Work With a Pro
If you want to take advantage of today’s tax exclusions or create an estate plan, you should talk to a financial planner ASAP. Many of our SmartVestor Pros are also certified financial planners. They’re RamseyTrusted and can help you plan the best way to leave a legacy for your family.
Or if you just need some old-fashioned advice from a tax pro, a RamseyTrusted Endorsed Local Provider (ELP) can help make your tax burden not feel like so much of a burden.