People sometimes hear bits and pieces about estate planning topics, and they go forward with certain misconceptions. We endeavor to clear up some of these misunderstandings from time to time, and we will address one of them in this blog post.
Taxes can come into play after someone passes away when assets are being transferred. There are federal taxes, and there are also a state-level taxes. While there is no tax that is formally called a “death tax,” this term is often used to describe the federal estate tax.
The estate tax is only applicable on asset transfers that exceed a certain amount, and there is no taxation on transfers between legally married spouses who are American citizens. The amount that you can transfer before the estate tax would be applicable is called the credit or exclusion. In 2016, the amount of this exclusion is $5.45 million.
Clearly, most Americans are not going to be in possession of assets that exceed $5.45 million, but you do have to be aware of the fact that real property and insurance policy proceeds are part of your estate for tax purposes. Here in Indiana, there are many farms, and farmland can be worth millions of dollars, even if the people working the land are not “cash-rich.” The top rate of the federal estate tax is 40 percent, so the impact can be significant if your estate is exposed.
In addition to the federal estate tax, there is also a gift tax. These two taxes were unified under the tax code during the 1970s. The gift tax has been in place continuously since 1932 to stop people from giving gifts to sidestep the estate tax. It carries the same 40 percent maximum rate, and the $5.45 million exclusion applies to lifetime gifts coupled with the value of your estate.
Once again, you can transfer unlimited assets to your spouse while you are living free of the gift tax, because there is an unlimited marital transfer tax exclusion.
In addition to the federal estate tax, there are also state-level estate taxes. Fortunately, most of the states in the union do not impose these taxes. The District of Columbia has its own estate tax, and 14 of the states levy estate taxes on the state level.
We practice law in the state of Indiana. There is no estate tax in our state, but this does not mean that state-level estate taxes can have no impact on your legacy. If you happen to own property in a state that does have its own estate tax, the laws of that state would apply when the property is being transferred. This is something that you should discuss with your estate planning attorney if you are an out-of-state property holder.
Now that we have looked at estate taxes, we can look at inheritance taxes. An estate tax would be applied to the entire taxable portion of an estate before the heirs receive their inheritances. There would not be multiple impositions of the tax when one estate is being administered.
Some people think that the terms “estate tax” and “inheritance tax” are interchangeable. In fact, an inheritance tax is not the same as an estate tax. An inheritance tax would be applied on transfers to each person who is receiving an inheritance, but some relationships can be exempt.
On the federal level, there is no inheritance tax. At this point, there are only six states that impose state-level inheritance taxes. Here in Indiana we did have an inheritance tax, and this is why some people assume that we are one of these states. In fact, the Indiana inheritance tax was retroactively repealed as of January 1st of 2013.
If you are curious about the six states that impose state-level estate taxes, they are New Jersey, Nebraska, Iowa, Kentucky, Pennsylvania and Nebraska. Residents of New Jersey and Maryland have to contend with a state-level estate tax and a state-level inheritance tax in addition to the federal estate tax.
Free Estate Tax Report
Estate taxes are not a factor for everyone, but those who are exposed can implement strategies that provide tax efficient asset transfers. Informed advance planning is the key to wealth preservation.
If you would like to explore the subject in some degree of detail, we are offering a valuable resource that you can access quickly and easily through this website. Our firm has prepared a special report on the estate tax and the strategies that can be implemented to ease the burden. The report is free, and you can click this link to access your copy: Estate Tax Report.
Mr. Kraft assists clients primarily in the areas of estate planning and administration, Medicaid planning, federal and state taxation, real estate and corporate law, bringing the added perspective of an accounting background to his work.