Estate tax is a tax imposed on the transfer of a deceased person’s estate to their heirs and beneficiaries. It is sometimes called a death tax and is calculated based on the total value of the estate at the time of death. Understanding how estate tax works, who is subject to it, and what strategies exist to minimize it can help families with larger estates plan more effectively.
Despite widespread concern about estate taxes the reality is that the vast majority of Americans will never pay federal estate tax because of the high exemption amounts that shield most estates from taxation.
How federal estate tax works
The federal estate tax is imposed on the taxable estate of a deceased person before assets are distributed to heirs. The taxable estate is calculated by taking the gross estate — the total value of all assets owned at death — and subtracting allowable deductions including debts, funeral expenses, and amounts passing to a surviving spouse or qualified charities.
The remaining taxable estate is then compared to the federal estate tax exemption. If the taxable estate exceeds the exemption the excess is subject to federal estate tax at a rate of up to 40 percent.
The federal estate tax exemption
The federal estate tax exemption is the amount of an estate that is shielded from federal estate tax. For 2024 the federal estate tax exemption is $13.61 million per individual. This means that an individual can pass up to $13.61 million in assets to heirs free of federal estate tax.
For married couples the exemption is effectively doubled through a concept called portability. Portability allows a surviving spouse to use any unused portion of their deceased spouse’s exemption in addition to their own. This means a married couple can potentially pass up to $27.22 million free of federal estate tax.
Sunset of the increased exemption
It is important to note that the current high exemption amount is the result of the Tax Cuts and Jobs Act of 2017 which temporarily doubled the estate tax exemption. Unless Congress acts the increased exemption is scheduled to sunset — expire — at the end of 2025 after which the exemption will revert to approximately $7 million per individual adjusted for inflation.
This scheduled change makes estate tax planning especially important for people with estates in the range of $7 million to $13 million who may be below the current exemption but above the post-sunset exemption.
Who pays federal estate tax
Because of the high exemption amount only a very small percentage of estates — less than one percent — are subject to federal estate tax. Federal estate tax is primarily a concern for people with very large estates including:
- Business owners with significant business interests
- People with large investment portfolios
- People who own substantial real estate
- People who have inherited significant wealth
For the vast majority of Americans federal estate tax is not a concern. However it is still important to understand how the system works especially given the potential changes when the current exemption sunsets.
State estate and inheritance taxes
In addition to the federal estate tax many states impose their own estate or inheritance taxes:
- State estate tax — similar to the federal estate tax imposed on the estate before distribution. States with estate taxes include Massachusetts, Oregon, Washington, Minnesota, Illinois, and others. State estate tax exemptions are typically much lower than the federal exemption — often $1 million to $4 million.
- Inheritance tax — imposed on the beneficiary who receives assets rather than on the estate itself. States with inheritance taxes include Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. Rates and exemptions vary by the beneficiary’s relationship to the deceased — spouses and children are often exempt or taxed at lower rates.
It is important to understand the estate and inheritance tax rules in your state especially if you live in a state with lower exemption amounts than the federal level.
The unlimited marital deduction
One of the most important provisions of federal estate tax law is the unlimited marital deduction. Assets passing from one spouse to another at death are generally not subject to federal estate tax regardless of the amount. This means that a married person can leave their entire estate to their surviving spouse free of federal estate tax.
However the unlimited marital deduction only defers estate tax — it does not eliminate it. When the surviving spouse dies their estate may be subject to estate tax on the combined assets. This is why married couples with large estates often use estate planning strategies to ensure they make full use of both spouses’ exemptions.
Common estate tax planning strategies
For people with estates large enough to be concerned about estate taxes there are several legal strategies that can help reduce or eliminate estate tax liability:
- Using both spouses’ exemptions — married couples should structure their estates to ensure that both spouses’ exemptions are fully utilized. This can be done through bypass trusts also called credit shelter trusts or through portability elections.
- Annual gifting — individuals can give up to $18,000 per year per recipient in 2024 without using any of their lifetime gift and estate tax exemption. Regular annual gifting can significantly reduce the size of a taxable estate over time.
- Irrevocable life insurance trust — ILIT — life insurance death benefits are included in the taxable estate if the insured owns the policy. An ILIT removes the life insurance from the taxable estate while providing the death benefit to heirs.
- Charitable giving — assets left to qualified charities are deductible from the taxable estate. Charitable giving strategies including charitable remainder trusts and charitable lead trusts can reduce estate taxes while supporting causes the grantor cares about.
- Grantor retained annuity trust — GRAT — allows the grantor to transfer appreciation in assets to heirs with little or no gift or estate tax
- Family limited partnership or family limited liability company — can be used to transfer business interests to heirs at a discounted value for estate tax purposes
The gift tax
The federal gift tax works in conjunction with the estate tax to prevent people from avoiding estate tax by giving away assets during their lifetime. The gift tax applies to transfers of property for less than fair market value during the giver’s lifetime.
The federal gift tax exemption is unified with the estate tax exemption — using your gift tax exemption during your lifetime reduces the estate tax exemption available at death. The annual gift tax exclusion — $18,000 per recipient in 2024 — allows individuals to make gifts up to this amount each year without using any of their lifetime exemption.
Key terms to know
- Estate tax — a tax imposed on the transfer of a deceased person’s estate to heirs
- Taxable estate — the value of the estate subject to estate tax after deductions
- Federal estate tax exemption — the amount of an estate that is shielded from federal estate tax — $13.61 million per individual in 2024
- Portability — the ability of a surviving spouse to use their deceased spouse’s unused estate tax exemption
- Unlimited marital deduction — the ability to pass unlimited assets to a surviving spouse free of federal estate tax
- Annual gift tax exclusion — the amount that can be given to any individual per year without using the lifetime gift and estate tax exemption — $18,000 in 2024
- Bypass trust — a trust used to ensure both spouses’ estate tax exemptions are fully utilized also called a credit shelter trust
- Sunset — the expiration of the increased estate tax exemption scheduled for the end of 2025
Sources
- Internal Revenue Service — irs.gov
- American Bar Association — Public Resources
- USA.gov — Estate Tax
This article is for general informational purposes only and does not constitute legal or financial advice. Estate tax laws are subject to change. Consult a licensed attorney and tax professional for guidance specific to your situation.