What Are Death Taxes? How to Reduce or Avoid Them

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What Are Death Taxes? How to Reduce or Avoid Them

What Are Death Taxes?

Death taxes are levied by the federal and certain state governments on the estates of the deceased. These taxes are charged on the beneficiary who gets the property in the will of the dead or the estate, which pays the tax before transferring the inherited property.

Death duties, estate taxes, and inheritance taxes are other names for death taxes.

Key Takeaways

  • Death taxes are government-imposed levies on the estates of the dead.
  • The word “death tax” refers to estate and inheritance taxes.
  • Death taxes are normally only levied on estates and inheritances worth a certain amount. To be subject to federal taxes in 2022, an estate’s assets must total $12.06 million.

Understanding Death Taxes

A death tax is any tax levied on the transfer of property after someone’s death. The phrase “death tax” became popular in the 1990s, when individuals who wanted estate and inheritance taxes abolished used it to characterize them. The deceased’s estate pays the estate tax before the assets are distributed to a recipient. The individual who inherits the assets pays the inheritance tax.

The federal government and several state governments levy an estate tax depending on the value of property and assets at the time of the owner’s death. The federal estate tax varies from 18% to 40% of the inheritance amount as of 2022. As of August 2022, twelve states levy a distinct state estate tax from the federal government. Connecticut, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Vermont, Washington, and the District of Columbia are among these states.

Although the federal government does not levy an inheritance tax, Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania do. However, property transferring to a surviving spouse is excluded from inheritance taxes in all of these states. In rare cases, Nebraska and Pennsylvania levy taxes on property passed down to a child or grandchild.

Death Tax Thresholds

Because the death tax only applies to a small number of individuals, most people avoid paying it. This is due to the 2017 Tax Cuts and Jobs Act, which applied the estate tax to the baseline exclusion limit, which is $12.06 million in 2022.

  Tax Refund Definition

The Tax Cuts and Jobs Act will expire in 2025. If Congress does not extend the legislation, the baseline exclusion amount will revert to pre-TCJA levels.

Assume a person leaves a non-exempt estate worth $12.8 million (adjusted for inflation) to his or her children and has never made any donations in excess of the exclusion limit. The amount above the federal threshold ($12.8 million – $12.06 million), $740,000, is liable to estate tax. The taxable amount is subject to a 37% tax plus a base tax of $155,800, according to the Unified Rate Schedule. As a result, the estate will owe a death tax of (37% x $740,000) + $155,800 = $429,600.

As a result, if a decedent’s estate is worth less than the statutory exemption amount for the year of death, the estate will not be subject to federal estate taxes.

Unified Tax Credit

The unified tax credit limits the amount of money a person may give away throughout their lifetime before any death or gift taxes apply. The tax credit combines the gift and estate taxes into a single tax system, lowering the person or estate’s tax payment dollar for dollar. Because some persons want to utilize the unified tax credits to reduce estate taxes after they die, the unified tax credit cannot be used to reduce gift taxes while they are still living. It may alternatively be used to the sum left to beneficiaries following death.

Unlimited Marital Deduction

The unlimited marital deduction, which permits a person to transfer an unrestricted amount of assets to their spouse at any time, even upon the transferor’s death, is another option available to lower death tax.

The clause repeals the federal estate and gift taxes on property transfers between spouses, thereby recognizing them as a single economic entity. The transfer to surviving spouses is made feasible by an unlimited deduction from estate and gift tax, which delays transfer taxes on property inherited from each other until the death of the second spouse.

  Preventing a Tax Hit When Selling Rental Property

The unlimited marital deduction allows married couples to postpone paying estate taxes after the death of the first spouse because, after the surviving spouse dies, all assets in the estate in excess of the applicable exclusion amount are included in the survivor’s taxable estate unless used up or gifted during the surviving spouse’s lifetime.

Advantages and Disadvantages of Death Taxes

Advantages
  • High threshold

  • High tax revenue

Advantages Explained

  • The death tax is triggered when estates are valued at more than $12.06 million, so only the extremely affluent need to be worried.
  • High tax revenue: Tax collections to the government were $17.6 billion in 2020, with forecasts of approximately $50 billion by 2030.

Disadvantage Explained

  • Double taxation: People with estates big enough to trigger death taxes will be taxed twice: once with income taxes and again with the estate tax.
  • Loopholes: Because there are methods to avoid paying estate taxes, it is natural for individuals with assets to take advantage of them.

How to Reduce or Avoid Death Taxes

Most individuals will not have to worry about death taxes since their assets do not exceed $12.06 million. If Congress does not reauthorize the Tax Cuts and Jobs Act beyond 2025, this sum might fall to $5 million or less—more than most individuals have.

If you have or anticipate to have enough assets to trigger death taxes, you may decrease or prevent them by doing the following:

  • Create an irrevocable trust: You may be able to safeguard your assets from estate taxes by putting them in an irrevocable trust. The money might then be distributed as income to you and your beneficiaries by the trust, lowering your tax burden. A grantor retained annuity trust is the most often utilized trust in this strategy (GRAT).
  • Give your assets to family and friends: You may do so tax-free as long as you don’t exceed the lifetime exclusion limit of $12.06 million ($24.12 million if you and your spouse give them away).
  • Enjoy your money: The greatest method to minimize estate taxes is to ensure that you leave enough for your family to live comfortably, then go out and enjoy the money you’ve worked so hard for.
  • Donations to charity organizations: Giving money to charitable organizations in which you believe may be fulfilling; you can also deduct contributions from your estate.
  Payroll Tax

How Do You Avoid Death Taxes?

Most individuals will not have to pay estate taxes, sometimes known as the death tax. However, if you have $12.06 million or more in assets, you may avoid paying taxes by donating to charity, giving away a portion of your estate, or putting it in special trust funds.

What States Have Death Taxes?

Connecticut, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Vermont, Washington, and the District of Columbia all have estate taxes.

Are There Death Taxes in the U.S.?

The federal government and 12 states have tax laws that levy inheritance taxes on estates with substantial assets.

The Bottom Line

The death tax is a tax levied on a person’s estate after they die. To be triggered by estate taxes, the estate must have large assets—more than $12.06 million in 2022. Most individuals will not be subject to a death tax, but for those who are, there are various strategies you may use to lessen or prevent the tax.

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