Understanding the Basics of Estate Tax Rate

An estate tax is levied on a deceased person’s estate before their assets are dispersed to their heirs. It is also known as an inheritance tax in some states.

Although taxes are imposed on only a portion of an estate’s value above an exemption amount, they raise very little revenue overall. Heirs often shield a substantial part of an estate from taxation through generous deductions, other discounts, and legal loopholes.

Rates

The estate tax is a death-related tax that applies to the value of an individual’s estate (the total of their assets) no matter who receives the property. It is also called an inheritance tax.

In the United States, estate and gift taxes are a part of what is sometimes called the federal unified transfer tax system. In this system, a person’s tax liability for both is calculated using the same schedule.

An essential difference between the two tax systems is that the estate tax can apply to various income and wealth-producing activities. In contrast, a gift tax is limited mainly to transfers to heirs.

The implication is that the efficiency effects of an estate tax depend crucially on why people give bequests. If legacies are unintentional, the tax has little impact on saving; if recipients of large inheritances increase their consumption spending and decrease their labor supply, the effect is more prominent.

Economists have discovered that the estate tax rate may have a favorable effect on saving in much empirical research. The heirs’ lesser net-of-tax inheritances may encourage them to spend less and save more.

Exemptions

The federal estate tax is a fee charged on the transfer of property at a person’s death. It touches cash, securities, real estate, business interests, and many other types of assets.

Exemptions from estate tax are available to individuals, couples, and families. They vary by state and are indexed for inflation.

However, the estate tax can eat into your wealth even with these exemptions. For example, if your estate is worth $1 million and your lifetime estate tax exemption amount is $3.5 million, the tax may eat away about half of your net value.

Ensuring your heirs have enough cash to live comfortably while you’re still living is an excellent strategy to lessen the burden of estate taxes. It can be done by giving your heirs money and property, such as a home or land, in the present.

Taxable estates

A taxable estate is the total value of your assets, including real estate, vehicles, jewelry, and more. This figure is calculated by taking the fair market value of these assets when you die.

The federal and most state taxes are assessed on the value of an estate that exceeds a certain threshold. This threshold is called the “federal estate tax exemption amount.”

Thankfully, most people do not pay this tax. It only affects the wealthiest 0.2 percent of U.S. households — less than one out of every 1,000.

Although the estate tax is a significant source of revenue for the federal government, it is not a tax on the middle class. It only affects the wealthiest households and is paid by billionaires and millionaires.

Marital deductions

The marital deduction is one of married couples’ most crucial estate planning options. It allows a spouse to avoid estate tax liability on property transferred to the surviving spouse.

To be eligible for the marital deduction, one must fulfill many conditions. Among them are that the transferring spouse must be married and that the property to be given away must come from the transferor’s gross estate.

In addition, the property to be given away must not be a terminable interest and cannot pass through any method other than the decedent’s will.

It’s also critical to remember that the marital deduction only postpones inheritance taxes, not eliminates them. It can only be used to defer taxes if the surviving spouse’s estate is sufficiently small to be protected by the lifetime exemption amount of the first spouse to die.

For this reason, marital deduction is often combined with other estate planning techniques. It may be used with a credit shelter trust to reduce the surviving spouse’s taxable estate.

Credits

While estate and inheritance taxation is a significant source of state revenue, it also encourages dead-weight losses, reduces economic efficiency, and sometimes breaks up farms and family-owned businesses. It also reduces the stock of capital in the economy, reducing after-tax returns to investment.

Many states have introduced or are considering introducing credits to offset taxes paid up to a certain amount. These essentially function as tax bracket eradication mechanisms, narrowing tax rates to lower levels.

Credits may be offered in combination with or in place of traditional exemptions. New York, for example, provides a credit that eliminates liability on the first $2 million of an adjusted taxable estate; however, this does not apply to the rest of the estate’s value.

Likewise, other states employ a credit that reduces the estate tax owed to the same amount as the exempted portion of an estate’s value. In addition, in 2011, the federal government began to allow the unused basic exclusion amount of a deceased spouse (the deceased spousal new exemption or DSUE) to be transferred to a surviving spouse by filing an estate tax return and making an election to do so.