Both testators (those giving gifts) and beneficiaries (those receiving gifts) should know about the tax consequences of the transfer of financial gifts upon death. Here is an explanation of the differences between the estate and inheritance tax, and how financial gifts given while living work. Keep in mind that while federal law controls nation-wide, state law regarding estate and inheritance taxes varies greatly state-to-state.
The estate tax is often called the “death tax” – it is imposed on an individual’s estate after he or she dies, where the value of the estate exceeds a limit established by law. Only the amount that exceeds that limit is subject to the tax. There is both federal tax that applies in all states and state tax in some states. Which state law applies is wherever the decedent lived at the time of death.
The estate is taxed at its fair market value at the time of death rather than what the decedent paid for assets at the time of acquisition.
There is what is called an unlimited marital deduction, which provides that estate tax is not imposed upon assets transferred to a surviving spouse.
As of the date of this writing, November 2019, the Internal Revenue Service (IRS) requires estates in excess of $11.4 million to pay estate tax. Again, only the portion of the estate that exceeds the $11.4 million will be taxed – at the rate of 40%.
As a threshold matter, estates valued at less than one million dollars are not taxed in any state. And, the amount imposed varies greatly from state-to-state.
Here are links to each state’s estate tax information:
First, the estate tax is what it sounds like – it is imposed on the estate itself, prior to the distribution of assets to beneficiaries. Inheritance tax, on the other hand, is paid by the beneficiaries based upon the value of what they inherit.
While there is no federal inheritance tax, as of this writing six states impose inheritance tax on the value of what is inherited by beneficiaries of an estate.
There is no federal inheritance tax, however, and only select states (as of 2019, Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania) still have their own inheritance taxes. Maryland alone has both an estate and an inheritance tax.
There are several factors that affect the amount of inheritance tax a beneficiary will pay:
As an aside, death benefits payable through the decedent’s life insurance policy is usually not subject to inheritance tax, but it may be subject to estate tax.
Here are links to each of the six states that impose inheritance tax:
Individuals often seek to avoid estate taxes by gifting to beneficiaries while living, in an amount that is less than the amount upon which the federal gift tax applies (as of this writing, up to $15,000). This is especially valuable when someone wishes to gift to another to whom he or she is not related, who might be subject to estate tax if the gift was transferred after death.
If you give such gifts and they happen to exceed the annual limit, that amount won’t be taxed in that year, and may never be taxed if your estate is not substantial. For example, if you give a gift of $18,000, the excess of $3,000 will be added to the value of your estate when you pass and will be taxed if your estate ends up exceeding the minimum imposed federally or in your state.
The bottom line is if you have substantial assets you have ways to avoid the worst of the taxes that might be imposed, by planning ahead. It is always advisable to seek the advice of a financial planning professional.
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