What is estate tax?

Very wealthy estates may have to pay a tax on assets they pass on to anyone other than a surviving spouse or qualified charity

Derek Silva

Derek Silva

Published July 17, 2019

KEY TAKEAWAYS

  • Estates worth at least $11.4 million — the 2019 exemption — must file an estate tax return using IRS Form 706

  • Estate tax only applies to the portion of the taxable estate that’s worth more than the exemption, unless it goes to a surviving spouse

  • Taxable gifts made during your lifetime will decrease your exemption

  • About a dozen states also have estate tax

Your estate is the collection of all your assets. That includes bank accounts, investments, real estate property, and anything else that contributes to your net worth. When you pass away, your estate will need to pay estate tax if its total value exceeds a certain amount. However, very few estates qualify for estate tax.

At the federal level, the first $11.4 million of your estate is exempt from taxation. So if your taxable estate is worth $11.5 million, you only pay estate tax on $100,000.

About a dozen states also levy an estate tax. Some of those states use the same exemption as federal law, but some have lower exemptions, which means you could have to pay tax to your state even if you don’t pay federally. Six states also collect an inheritance tax (which we’ll discuss later) from beneficiaries.

The person who handles all of the tax bills on behalf of your estate is your executor. Many people name an executor in their will, but a court appoints someone to do the job if you don’t name anyone.

Knowing the value of your estate before you pass away is an important part of estate planning. Having a good plan in place will make taxes easier for your executor and beneficiaries. If you know your estate is near the exemption, you may also be able to take steps to decrease its value. And don’t forget to plan around the value of your spouse’s estate, especially if you plan to leave any of your estate to them.

In this article:

The role of the executor

Before someone passes away, they generally name an executor in their will. The executor, also called a personal representative, handles an estate’s finances and disbursement of assets to beneficiaries. Executors generally manage the estate until it has been through probate and all assets have been transferred to the proper owners.

An executor can be a surviving spouse, beneficiary, or someone else entirely. (If you don’t name anyone, a court will appoint an administrator to handle the duties.) Executors can also hire the necessary attorneys, tax accountants, or other professionals as long as they’re acting in the best interest of the estate.

Note that for tax reasons, an estate is a separate legal entity. Even though an executor is filing its tax returns, any income tax, property tax, and estate tax bills apply to the estate itself, not to the executor or beneficiaries.

Finding the value of an estate

To determine whether or not an estate has to file a tax return, the executor must calculate the estate’s gross assets — the total, fair market value of all its assets.

The estate’s value includes anything that contributed to the net worth of the deceased person (also called the decedent): bank accounts, investments, real estate, businesses, and any other personal property. The Internal Revenue Service (IRS) allows two ways to determine gross assets, based on either the estate’s value at the time of death or its value six months after the decedent’s death.

Estate tax exemption

Estate tax is only due if an estate’s value exceeds the estate tax exemption amount, which is $11.4 million for deaths in 2019. That high threshold means very few estates actually have to pay estate tax each year.

The exemption may also change slightly from year to year because it’s indexed to inflation. For example, the 2018 exemption was $11.18 million. It increased greatly from 2017 to 2018 because of the law changes from the Tax Cuts and Jobs Act.

Tax yearExemption amount
2017$5.49 million
2018$11.18 million
2019$11.40 million

The exemption for an individual estate may be lower, though, because an estate’s actual exemption is calculated as the federal exemption minus any money and assets the owner gifted to others during their life. So if you gift $400,000 to your children during your life (and report it on your taxes) then the IRS will calculate your estate’s exemption as only $11 million when you pass away.

What if you own a family farm?

If someone owns any part of a farm business, the value of their ownership is included in the gross estate. Family-owned farms qualify for a deduction in value worth up to $1.16 million in 2019. There is no equivalent deduction for other businesses, but their value is still part of the gross estate.

Paying the estate tax bill

If the value of an estate exceeds the deceased person’s exemption, the executor will need to file an estate tax return within nine months of death. They must do so with IRS Form 706. This form requires some personal information on the decedent and executor, as well as the fair-market values of estate assets.

The executor can also get a six-month filing extension (giving them 15 months after the death to file a return) using IRS Form 4768. The extension is guaranteed so anyone who submits the form on time will get it.

However, even if the estate has to file a tax return, it may not owe any taxes. Estate tax only applies to the portion of the taxable estate that exceeds the exemption. The taxable estate is the gross estate minus certain deductions. Common deductions include the value of mortgages, other debts, the cost of managing the estate, and any assets that are going to a surviving spouse or qualified charity.

It is possible for an estate to exceed the exemption for gross assets, but to not owe estate tax because deductions bring the taxable estate below the exemption.

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Federal estate tax rates for 2019

The federal estate tax has marginal tax brackets that range from 18% to 40% for the 2019 tax year. With marginal rates, you only pay a certain tax rate on the money that falls within the bracket. You can see the federal estate tax rates in the table below.

Taxable estate value (above the exemption)Tax rateTotal maximum tax
$0 to $10,00018%$1,800
$10,000 to $20,00020%$3,800
$20,000 to $40,00022%$8,200
$40,000 to $60,00024%$13,000
$60,000 to $80,00026%$18,200
$80,000 to $100,00028%$23,800
$100,000 to $150,00030%$38,800
$150,000 to $250,00032%$70,800
$250,000 to $500,00034%$155,800
$500,000 to $750,00037%$248,300
$750,000 to $1 million39%$345,800
$1 million+40%$345,800 + 40 cents for every dollar above $1 million

States with an estate tax

In addition to the federal estate tax, some states levy their own estate tax. The executor must also file and pay these before distributing assets to beneficiaries.

As of the 2019 tax year, 12 states and the District of Columbia have an estate tax:

  • Connecticut
  • District of Columbia
  • Hawaii
  • Illinois
  • Maine
  • Maryland
  • Massachusetts
  • Minnesota
  • New York
  • Oregon
  • Rhode Island
  • Vermont
  • Washington

Many states use the federal exemption amount ($11.4 million for 2019) but others have lower exemptions. That means an estate may not have to file a federal tax return, but it may still have to pay tax at the state level. Six states also tax beneficiaries through an inheritance tax.

Passing an estate to your spouse

When an estate passes to a surviving spouse, it doesn’t owe estate tax because of the marital deduction. The deduction allows someone to transfer unlimited assets to their spouse — before or after death — without having to pay tax on the transfer. However, the estate still needs to file a return if its value exceeds the exemption. The marital deduction doesn’t apply to a common-law partner or other unmarried partner.

The IRS also allows for a decedent’s unused lifetime exemption to carry over to their surviving spouse. The surviving spouse must elect to add the exemption to their own, and they generally must do so by the time the estate tax return is due. This is called the portability election.

So if someone dies without using any of their exemption and their surviving spouse elects to add it to their own exemption, then the surviving spouse’s can potentially have an exemption that’s double the normal exemption amount.

An estate must file Form 706 to use the portability election, so a surviving spouse may want (the executor) to file federal estate tax forms even if no estate taxes are owed.

Should you file a tax return if you don’t need to?

First of all, an estate’s executor must file a standard income tax return (with IRS Form 1041) if the estate earns income. They may also have to pay property taxes for the estate. But the executor may also want to file an estate tax return, even if there’s no tax bill.

As mentioned in the previous section, an estate tax return is necessary if you want to use the portability election. You may also opt to file Form 706 to the IRS if you want to lock in the fair market value of assets.

The tax return requires you to state the value of an estate’s assets, and having an official record of those values can make it easier to manage the estates of surviving spouses and other beneficiaries down the road. For example, knowing the exact value of an investment when it was received will make it easier to calculate its capital gains down the road.

With that being said, this scenario only really applies if a surviving spouse or beneficiary thinks their future estate will have a value near or above the exemption. If their estate’s value is below the exemption, neither they nor their future executor will ever have to worry about the estate tax.

Also be aware that the current estate tax exemption is set to expire at the end of 2025. It’s possible the exemption will return to its previous amount (about $5.5 million) at that time.

Consider talking with a financial advisor if you’re unsure whether you should file an estate tax return.

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Takeaway

A trust is a legal entity that can protect your assets for use by you or your loved ones.

Estate tax vs inheritance tax

There is no inheritance tax at the federal level, but six states do collect an inheritance tax. This differs from estate tax because the person inheriting an asset pays a tax based on the value of what they inherited. Estate tax applies to the value of the whole estate, before any assets have gone to beneficiaries, and the estate is the one paying the tax bill.

The following six states have an inheritance tax in 2019:

  • Iowa
  • Kentucky
  • Maryland
  • Nebraska
  • New Jersey
  • Pennsylvania

Inheritance tax only applies if the deceased person lived in one of these states or if a property you inherit is in one of these states. It doesn’t actually matter which state you live in.

Surviving spouses are also exempt from inheritance tax. Direct descendents usually pay lower tax rates but they are completely exempt in certain states. The less closely related you are to the deceased person, the higher your top tax rate usually is, with unrelated individuals paying the highest rates. States usually have marginal tax rates with a top rate of between 15% and 20%. Rates may also vary based on the type of asset you’re inheriting and the age of the inheritor.

Tax returns and bills for inheritance tax are usually due eight or nine months after the death, but laws vary by state so make sure to check with your state’s tax department.

How to avoid estate tax

The most popular way to avoid estate tax or to reduce your tax bill is to create a trust. A trust is a separate legal entity and you can decrease the value of your estate by transferring your assets into the trust. The trust then becomes the legal owner, and someone of your choosing will manage it and disburse assets to your beneficiaries after your death.

Credit-shelter trusts are particularly useful because they allow your surviving spouse to access the money from your estate without adding to the value of their own estate.

Learn more about how trusts work and whether you should consider one.

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