Estate Tax

Estate Tax

Estate tax is a federal (and sometimes state-level) tax levied on the total value of a deceased person’s assets before those assets are distributed to heirs or beneficiaries.

How It Works

When a person dies, their estate, which typically includes real estate, bank accounts, investments, business interests, and personal property, is assigned a total fair market value. If that total value exceeds a certain threshold, known as the estate tax exemption, the amount above that threshold is generally subject to tax. The estate itself pays the tax before any assets are transferred to heirs, meaning beneficiaries typically receive their inheritance after the tax obligation has already been settled.

The federal estate tax exemption is adjusted periodically. As of 2024, the federal exemption sits at approximately $13.61 million per individual. Estates with a total value below this threshold generally owe no federal estate tax at all. For estates that do exceed the exemption, the federal tax rate can reach up to 40% on the taxable portion.

It is important to note that estate tax is separate from inheritance tax. Estate tax is paid by the estate, while inheritance tax (where it applies) is paid by the individual who receives the assets. The federal government does not impose an inheritance tax, though some states do.

Practical Examples

Example 1: Estate Below the Exemption

Consider a person who passes away in 2024 with a total estate valued at $4 million. Because this amount falls well below the federal exemption of $13.61 million, the estate typically owes zero federal estate tax. The full value of the estate would generally pass to heirs without a federal tax burden.

Example 2: Estate Above the Exemption

Now consider a person with a total estate valued at $20 million. After subtracting the $13.61 million exemption, the taxable portion of the estate is approximately $6.39 million. Applying the top federal rate of 40% to that taxable amount results in a federal estate tax bill of roughly $2.56 million. The estate would need to pay this amount, often by liquidating assets, before distributing the remaining value to beneficiaries.

Why It Matters

For most people, federal estate tax is not a concern because the exemption is quite high. However, estate tax planning becomes increasingly relevant for individuals with significant assets, business owners, and those with large real estate holdings. In most cases, early and careful planning can affect how much of an estate is preserved for the next generation.

Several common strategies are generally used to reduce potential estate tax exposure:

• Gifting during life: Transferring assets to heirs while still alive can reduce the size of a taxable estate, subject to annual and lifetime gift tax limits.
• Trusts: Certain types of trusts, such as irrevocable life insurance trusts, are commonly used to remove assets from a taxable estate.
• Charitable donations: Assets left to qualified charitable organizations are generally excluded from estate tax calculations.
• Marital deduction: Assets passed directly to a surviving spouse typically qualify for an unlimited marital deduction, deferring estate tax until the second spouse’s death.

State Estate Taxes

In addition to the federal estate tax, roughly a dozen states and the District of Columbia impose their own estate taxes. State exemptions are often lower than the federal threshold. For example, some states begin taxing estates valued above $1 million, meaning residents in those states may face a state-level estate tax even when no federal estate tax applies.

Related Tax Concepts

Readers exploring estate tax may also find it helpful to review these related topics:

• Gift Tax: The tax applied to transfers of assets made during a person’s lifetime that exceed annual and lifetime exclusion limits.
• Inheritance Tax: A state-level tax paid by the beneficiary who receives assets from an estate.
• Step-Up in Basis: A rule that adjusts the cost basis of inherited assets to their fair market value at the time of death, potentially reducing capital gains tax for heirs.
• Generation-Skipping Transfer Tax (GSTT): A tax that generally applies when assets are transferred to beneficiaries who are two or more generations below the original owner.