Understanding the Federal Estate Tax: What You Need to Know
What is the Federal Estate Tax?
The federal estate tax, often referred to as the “death tax,” is a tax levied on the assets of a deceased individual. The rate of this tax varies between 18% and 40%, typically applying to estates valued above $13.99 million in 2025 or $15 million in 2026. It’s essential to understand this tax, especially when planning your estate or managing assets after a loved one’s passing.
Key Points:
- Tax Rate: Ranges from 18% to 40%
- Exemption Thresholds: $13.99 million (2025), $15 million (2026)
Estate Tax Exemptions for 2025 and 2026
The estate tax exemption applies on a per-person basis, meaning that a married couple can effectively double the exemption. However, several states impose their own estate taxes, often with lower exemption thresholds than the federal level. Thus, it’s crucial to be aware of both federal and state laws affecting your estate.
State-Level Considerations
The estate tax regulations can vary significantly from state to state. It’s advisable to consult your state’s department of revenue or taxation for up-to-date information on estate taxes in your area.
How the Federal Estate Tax Operates
The federal estate tax is based on the fair market value of a deceased individual’s assets, not their original purchase price. This ensures that the tax reflects current valuations. It is important to note that assets inherited by a surviving spouse typically qualify for an unlimited marital deduction, meaning they are not subject to the federal estate tax.
Filing the Estate Tax
To calculate the estate tax due, you will need to fill out IRS Form 706, which details which assets are included in the estate tax calculations, how to assess their value, and how to determine tax obligations.
Estate Tax Rates and Limits
The estate tax is calculated using a tiered rate structure, which means the percentage increases based on the value of the estate. Below is the breakdown of rates as applicable:
- $1,800 plus 20% on amounts over $10,000
- $3,800 plus 22% on amounts over $20,000
- $8,200 plus 24% on amounts over $40,000
- $13,000 plus 26% on amounts over $60,000
- … and so on up to $345,800 plus 40% on amounts over $1,000,000
Which States Have an Estate Tax?
Multiple states enforce their own estate taxes, often with thresholds lower than the federal exemption. If you reside in a state with an estate tax, the bill may be deducted from your taxable estate, thereby reducing the amount subject to federal tax.
Estate Tax Exemptions by State
Each state has different estate tax exclusions, so reviewing state-specific regulations is vital for comprehensive estate planning.
Inheritance Tax vs. Estate Tax: What’s the Difference?
It’s important to differentiate between an inheritance tax and an estate tax.
- Inheritance Tax: Paid by heirs receiving assets from a deceased person.
- Estate Tax: Paid on the entire taxable estate itself.
Five states impose an inheritance tax, which generally varies according to the heir’s relationship to the deceased. For example, a surviving spouse is generally exempt, while more distant relatives may pay higher rates.
Reducing or Avoiding the Federal Estate Tax
If you want to minimize your estate tax liability, consider the following strategies:
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Spend Your Assets: Use your wealth during your lifetime if you’re not concerned about running out of money.
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Gift Your Assets: Giving gifts during your lifetime can reduce the taxable value of your estate. Many states do not tax these gifts.
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Charitable Donations: Inheriting or donating assets to a qualifying charity can deduct them from your gross estate.
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Establish Trusts: Properly structured irrevocable trusts can shelter assets from tax liabilities.
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Relocate: Moving to a state with no estate or inheritance tax can significantly reduce your tax burden.
Important Considerations for Inherited Assets
While inheriting assets may not incur an estate tax, any income generated or subsequent earnings from these assets may still be subject to capital gains tax at both state and federal levels. If heirs decide to sell inherited assets, profits will be taxed as either long-term or short-term capital gains, depending on the selling time frame.
Seeking Professional Advice
For substantial bequests, consulting with a financial advisor can provide insights into minimizing capital gains tax obligations.
Final Thoughts
Navigating the complexities of the federal estate tax and associated state taxes can be daunting. Understanding the rates, exemptions, and potential strategies for reducing tax liabilities is crucial for effective estate planning and management. Always consult with a professional advisor to ensure compliance and optimize your financial strategy.
By being well-informed, you can better plan for the future and safeguard your estate for your heirs.
